-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, IPGPeZwDFedbnwE6TqhYSiBLBPsHFCcd9N0vEirJklAavhbVh0W/hLgU9z69kJIY 1PZyO2avM68Rk0/+eqTaKg== 0000928385-98-001511.txt : 19980803 0000928385-98-001511.hdr.sgml : 19980803 ACCESSION NUMBER: 0000928385-98-001511 CONFORMED SUBMISSION TYPE: 8-K PUBLIC DOCUMENT COUNT: 17 CONFORMED PERIOD OF REPORT: 19980729 ITEM INFORMATION: ITEM INFORMATION: FILED AS OF DATE: 19980729 SROS: NASD FILER: COMPANY DATA: COMPANY CONFORMED NAME: SYLVAN LEARNING SYSTEMS INC CENTRAL INDEX KEY: 0000912766 STANDARD INDUSTRIAL CLASSIFICATION: SERVICES-EDUCATIONAL SERVICES [8200] IRS NUMBER: 521492296 STATE OF INCORPORATION: MD FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 8-K SEC ACT: SEC FILE NUMBER: 000-22844 FILM NUMBER: 98672978 BUSINESS ADDRESS: STREET 1: 1000 LANCASTER ST CITY: BALTIMORE STATE: MD ZIP: 21202 BUSINESS PHONE: 4108438000 MAIL ADDRESS: STREET 1: 1000 LANCASTER ST CITY: BALTIMORE STATE: MD ZIP: 21202 8-K 1 FORM 8-K SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 8-K CURRENT REPORT Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 Date of Report (Date of earliest event reported): July 29, 1998 SYLVAN LEARNING SYSTEMS, INC. ----------------------------- (Exact name of registrant as specified in its charter) Maryland 0-22844 52-1492296 ---------- ------- ---------- (State of Incorporation) (Commission File Number) (IRS Employer Identification Number) 1000 Lancaster Street Baltimore, Maryland 21202 ----------------------- ----- (Address of principal executive offices) (Zip Code) (410) 843-8000 -------------- (Registrant's telephone number) Item 5. Other Events. The supplemental consolidated financial statements of Sylvan Learning Systems, Inc. ("the Company") included herein for each of the three years in the period ended December 31, 1997 and for the quarters ended March 31, 1998 and 1997 have been restated to give retroactive effect to the Company's merger with Aspect International Language Schools, B.V. and subsidiaries ( "Aspect") on May 6, 1998. The merger was accounted for by the Company as a pooling-of-interests and, accordingly, the Company's financial statements have been restated for all periods prior to the merger to include the results of operations, financial position and cash flows of Aspect. As of the date of this report, the Company has not issued financial statements for a period including the merger date and, therefore, the financial statements are considered "supplemental." Upon the issuance of financial statements for a period that includes the date of the merger, the supplemental consolidated financial statements will become the historical consolidated financial statements of the Company. Also included herein is a revised Management's Discussion and Analysis of Financial Condition and Results of Operations based on the supplemental consolidated financial statements described above. 2 SELECTED SUPPLEMENTAL CONSOLIDATED FINANCIAL DATA (1) The selected supplemental statements of operations data for the year ended December 31, 1993 consist of the results of Sylvan KEE Systems, a Maryland general partnership into which Sylvan Learning Corporation contributed the Sylvan Learning Centers business in January 1993, plus Sylvan results for the eleven months ended December 31, 1993. The supplemental selected financial data for the years ended December 31, 1994 through 1997 have been derived from Sylvan's supplemental consolidated financial statements which have been audited by Ernst & Young LLP. The selected supplemental financial data have been adjusted for the 3-for-2 stock dividend paid on May 22, 1998, and the restatement of the Company's financial statements as a result of accounting for the ASPECT acquisition as a pooling-of-interests.
PARTNERSHIP SYLVAN AND SYLVAN --------------------------------------------------------- COMBINED YEAR ENDED THREE MONTHS YEAR ENDED DECEMBER 31, ENDED MARCH 31, DECEMBER 31, ------------------------------------- ------------------ 1993 1994 1995 1996 1997(2) 1997(3) 1998(3) ------------ ------- -------- -------- -------- -------- -------- (IN THOUSANDS, EXCEPT PER SHARE DATA) STATEMENTS OF OPERATIONS DATA: Revenues............... $71,091 $92,881 $137,717 $217,874 $298,671 $ 60,821 $ 86,323 Cost and expenses: Direct costs........... 63,053 83,945 122,806 185,356 259,083 53,586 76,781 General and administrative expense(4)............ 6,255 4,998 6,205 8,755 22,076 2,961 3,327 Loss on impairment of assets................ -- -- 3,316 -- 4,000 -- -- ------- ------- -------- -------- -------- -------- -------- Total costs and expenses.............. 69,308 88,943 132,327 194,111 285,159 56,547 80,108 ------- ------- -------- -------- -------- -------- -------- Operating income....... 1,783 3,938 5,390 23,763 13,512 4,274 6,215 Non-operating income (expense)............. (102) 266 1,402 2,105 31,323 653 536 Interest (expense), net................... (1,611) (313) (2,623) (1,296) (785) (318) (169) ------- ------- -------- -------- -------- -------- -------- Income from continuing operations before income taxes and extraordinary items... 70 3,891 4,169 24,572 44,050 4,609 6,582 Income taxes........... (79) (182) (356) (9,135) (16,426) (1,955) (2,315) ------- ------- -------- -------- -------- -------- -------- Income (loss) from continuing operations before extraordinary items................. (9) 3,709 3,813 15,437 27,624 2,654 4,267 ------- ------- -------- -------- -------- -------- -------- Income from discontinued operations(5)......... 205 -- -- -- -- -- -- ------- ------- -------- -------- -------- -------- -------- Net income before extraordinary items... 196 3,709 3,813 15,437 27,624 2,654 4,267 Extraordinary items(6).............. (177) -- -- -- -- -- -- ------- ------- -------- -------- -------- -------- -------- Net income............. $ 19 $ 3,709 $ 3,813 $ 15,437 $ 27,624 $ 2,654 $ 4,267 ======= ======= ======== ======== ======== ======== ======== Earnings from continuing operations per diluted share(7).. $ -- $ 0.14 $ 0.14 $ 0.40 $ 0.62 $ 0.06 $ 0.09 ======= ======= ======== ======== ======== ======== ======== Diluted shares(7)...... 11,676 26,433 27,622 38,884 44,811 42,882 49,926 ======= ======= ======== ======== ======== ======== ======== BALANCE SHEET DATA (AT PERIOD END): Cash and cash equivalents........... $12,711 $ 6,965 $ 6,488 $ 18,565 $ 29,650 $ 18,407 $ 26,517 Available-for-sale securities............ 1,248 2,537 30,735 16,449 82,926 10,730 57,880 Net working capital.... 11,894 12,813 38,870 28,654 112,755 37,727 80,703 Intangible assets and deferred contract costs................. 7,002 8,098 83,192 123,373 193,109 121,387 216,048 Total assets........... 51,451 62,320 187,744 277,614 496,313 279,862 504,288 Long-term debt, including current portion............... 8,778 12,077 12,028 39,412 74,579 25,021 50,693 Stockholders' equity... 26,243 33,967 138,904 182,524 340,248 203,280 373,164
- -------- (1) As of the date of this Offering Memorandum, the Company has not issued financial statements for a period including the ASPECT acquisition date and, therefore, the financial statements are considered "supplemental." Upon the issuance of financial statements for a period that includes the date of the ASPECT acquisition, the supplemental consolidated financial statements will become the historical consolidated financial statements of the Company. Prior to February 1, 1991, the Sylvan Learning Centers business was conducted by Sylvan Learning Corporation (the "Predecessor"). On February 1, 1991, the Predecessor contributed the Sylvan Learning 3 Centers business to Sylvan KEE Systems, a Maryland general partnership (the "Partnership") in exchange for a 50% partnership interest, and Sylvan contributed its computer training software development business to the Partnership in exchange for the other 50% partnership interest. On January 26, 1993, Sylvan acquired the Predecessor and dissolved the Partnership. On September 3, 1993, Sylvan sold its computer training software development business. During 1994, Sylvan acquired by mergers all of the outstanding stock of LSI and Loralex. These companies owned and operated a total of nine Sylvan Learning Centers located in the Northeast United States and Florida. On February 17, 1995, Sylvan acquired by merger all of the outstanding stock of READS, a Philadelphia-based provider of remedial education and a variety of consulting services to school districts, county-wide educational agencies and municipalities in the Eastern United States. The READS, Loralex and LSI acquisitions have been accounted for by Sylvan as poolings-of-interests and, accordingly, Sylvan's financial statements have been restated for all periods prior to the acquisitions. Effective September 30, 1995, Sylvan acquired Drake, a leading provider of computer-based certification, licensure and assessment testing. The transaction was accounted for as a purchase, and Sylvan's results of operations from October 1, 1995 include the operations of Drake. Effective December 1, 1996, Sylvan acquired Wall Street, a European-based franchisor and operator of learning centers that teach the English language. This transaction was accounted for as a purchase, and Sylvan's results of operations from December 1, 1996 include the operations of Wall Street. Sylvan paid $4.9 million of the $21.1 million purchase price in cash and the remainder in 1,072,326 shares of Common Stock. On May 30, 1997, the Company acquired Educational Inroads, a provider of contract educational services to school districts in New Jersey and several other states. The Educational Inroads acquisition was accounted for by Sylvan as a pooling-of-interests, and, accordingly, Sylvan's financial statements have been restated for all periods prior to the acquisition. On January 1, 1998, the Company acquired all of the outstanding capital stock of Canter for $25 million plus additional consideration if Canter achieves certain EBITDA targets. The acquisition was accounted for as a purchase, and Sylvan's results of operations from January 1, 1998 include the operations of Canter. On May 6, 1998, Sylvan exchanged 2,004,030 shares of its stock (having a market value of $65.0 million) for all of the outstanding equity interests in ASPECT in a transaction accounted for as a pooling-of-interests, and accordingly, Sylvan's financial statements have been restated for all periods prior to the acquisition. (2) Includes $5.4 million of non-recurring expenses related to accounting for the ASPECT acquisition as a pooling-of-interests. These expenses include shareholder compensation and related expenses and transaction costs totaling $2.5 million and a contribution of $2.9 million to a not-for- profit foundation. Additionally, 1997 includes the following non-recurring items: the $28.5 million net NEC termination fee, Sylvan's impairment loss of $4.0 million and $21.5 million of expenses related to contributions to several not-for-profit entities. The approximate net effect of these items was to increase income before tax by $3.0 million and net income by $1.9 million. (3) Includes a pre-tax loss for ASPECT in the first quarter of 1997 and 1998 of $1.1 million and $1.9 million, respectively. (4) The Company has reclassified certain operating expenses previously included in general and administrative expense to direct costs. This change has been reflected for all periods presented. (5) Represents Sylvan's computer training software development business, which was sold in September 1993. (6) Represents the $350,000 gain on extinguishment of a $3.5 million debt and a $527,000 loss on extinguishment of $5.0 million of notes payable to stockholders, each recorded in 1993. (7) All share and per share data have been restated to reflect a 3-for-2 stock dividend paid on November 7, 1996 and a 3-for-2 stock dividend paid on May 22, 1998. 4 ITEM 7. SUPPLEMENTAL FINANCIAL STATEMENTS AND EXHIBITS ---------------------------------------------- (a) Exhibits --- -------- 23.01 Consent of Ernst & Young LLP 23.02 Consent of Deloitte & Touche LLP 23.03 Consent of Deloitte & Touche 23.04 Consent of Smith, Lange & Phillips LLP 27.00 Restated Financial Data Schedule 99.1 Management's Discussion and Analysis of Financial Condition and Results of Operations for the Years Ended December 31, 1997, 1996, and 1995 and for the three months ended March 31, 1998 and 1997. 99.2 Supplemental Consolidated Financial Statements for each of the three years in the period ended December 31, 1997. 99.3 Supplemental Consolidated Financial Statements for the three months ended March 31, 1997 and March 31, 1998 (unaudited) 99.4 Opinion of Deloitte & Touche 99.5 Opinion of Smith, Lange & Phillips LLP 99.6 Opinion of Smith, Lange & Phillips LLP 99.7 Opinion of Smith, Lange & Phillips LLP 5 SIGNATURES ---------- Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. Date: July 29, 1998 SYLVAN LEARNING SYSTEMS, INC. By: /s/ B. Lee McGee ----------------- B. Lee McGee, Executive Vice President and Chief Financial Officer 6 EX-23.01 2 EXHIBIT 23.01 Exhibit 23.01 Consent of Ernst & Young LLP, Independent Auditors We consent to the incorporation by reference in the following Registration Statements of our report dated July 28, 1998, with respect to the supplemental consolidated financial statements of Sylvan Learning Systems, Inc. included in the Current Report on Form 8-K dated July 29, 1998. Registration Statements on Form S-3: Registration Number Date Filed - -------------------------------- -------------------- 33-92014 May 8, 1995 33-92852 May 30, 1995 333-1674 February 26, 1996 333-16111 November 14, 1996 333-21261 February 6, 1997 333-26633 May 7, 1997 333-31273 July 15, 1997 333-39535 November 5, 1997 333-43355 December 29, 1997 333-46747 February 23, 1998 333-48997 March 31, 1998 333-50993 April 24, 1998 Registration Statements on Form S-8: Registration Name Number Date Filed - ------------------------------------- ------------------ ------------------ 1987-1991 Employee Stock Option Plan 33-77384 April 6, 1994 1993 Director Stock Option Plan 33-77386 April 6, 1994 1993 Employee Stock Option Plan 33-77390 April 6, 1994 1993 Management Stock Option Plan 33-77388 April 6, 1994 1997 Employee Stock Purchase Plan 333-21963 February 18, 1997 ERNST & YOUNG LLP Baltimore, Maryland July 28, 1998 EX-23.02 3 EXHIBIT 23.02 EXHIBIT 23.02 INDEPENDENT AUDITOR'S CONSENT We consent to the incorporation by reference in the following Registration Statements of our reports dated March 14, 1997, with respect to the financial statements of Independent Child Study Teams, Inc. and I-R, Inc. included in the Form 8-K dated July 29, 1998. REGISTRATION STATEMENT ON FORM S-3
Registration Number Date Filed - -------------------------------------------------------------------------------- 33-92014 May 8, 1995 33-92852 May 30, 1995 333-1674 February 26, 1996 333-16111 November 14, 1996 333-21261 February 6, 1997 333-26633 May 7, 1997 333-31273 July 15, 1997 333-39535 November 5, 1997 333-43355 December 29, 1997 333-46747 February 23, 1998 333-48997 March 31, 1998 333-50993 April 24, 1998
Registration Statement on Form S-8
Name Registration Number Date Filed - -------------------------------------------------------------------------------- 1987-1991 Employee Stock Option Plan 33-77384 April 6, 1994 1993 Director Stock Option Plan 33-77386 April 6, 1994 1993 Employee Stock Option Plan 33-77390 April 6, 1994 1993 Management Stock Option Plan 33-77388 April 6, 1994 1997 Employee Stock Purchase Plan 333-21963 February 18, 1997
DELOITTE & TOUCHE LLP Parsippany, New Jersey July 27, 1998 EX-23.03 4 EXHIBIT 23.03 EXHIBIT 23.03 CONSENT OF DELOITTE & TOUCHE, INDEPENDENT AUDITORS We consent to the incorporation by reference in the following Registration Statements, all of Sylvan Learning Systems, Inc., of our report dated July 27, 1998, with respect to the consolidated financial statements of Anglo-World Education (UK) Limited and Subsidiaries included in the Current Report on Form 8-K dated July 29, 1998. REGISTRATION STATEMENT ON FORM S-3
Registration Number Date Filed - -------------------------------------------------------------------------------- 33-92014 May 8, 1995 33-92852 May 30, 1995 333-1674 February 26, 1996 333-16111 November 14, 1996 333-21261 February 6, 1997 333-26633 May 7, 1997 333-31273 July 15, 1997 333-39535 November 5, 1997 333-43355 December 29, 1997 333-46747 February 23, 1998 333-48997 March 31, 1998 333-50993 April 24, 1998
REGISTRATION STATEMENT ON FORM S-8
Name Registration Number Date Filed - -------------------------------------------------------------------------------- 1987-1991 Employee Stock Option Plan 33-77384 April 6, 1994 1993 Director Stock Option Plan 33-77386 April 6, 1994 1993 Employee Stock Option Plan 33-77390 April 6, 1994 1993 Management Stock Option Plan 33-77388 April 6, 1994 1997 Employee Stock Purchase Plan 333-21963 February 18, 1997
DELOITTE & TOUCHE United Kingdom July 27, 1998 EX-23.04 5 EXHIBIT 23.04 EXHIBIT 23.04 CONSENT OF SMITH, LANGE & PHILLIPS LLP, INDEPENDENT AUDITORS We consent to the incorporation by reference in the following Registration Statements all of Sylvan Learning Systems, Inc., our reports listed below with respect to the consolidated financial statements of American Study Program for Educational and Cultural Training, Inc. included in the Current Report on Form 8-K dated July 29, 1998.
September 30, 1995 dated June 11, 1998 September 30, 1996 dated December 10, 1996 September 30, 1997 dated December 7, 1997
REGISTRATION STATEMENT ON FORM S-3:
Registration Number Date Filed - -------------------------------------------------------------------------------- 33-92014 May 8, 1995 33-92852 May 30, 1995 333-1674 February 26, 1996 333-16111 November 14, 1996 333-21261 February 6, 1997 333-26633 May 7, 1997 333-31273 July 15, 1997 333-39535 November 5, 1997 333-43355 December 29, 1997 333-46747 February 23, 1998 333-48997 March 31, 1998 333-50993 April 24, 1998
REGISTRATION STATEMENT ON FORM S-8:
Name Registration Number Date Filed - -------------------------------------------------------------------------------- 1987-1991 Employee Stock Option Plan 33-77384 April 6, 1994 1993 Director Stock Option Plan 33-77386 April 6, 1994 1993 Employee Stock Option Plan 33-77390 April 6, 1994 1993 Management Stock Option Plan 33-77388 April 6, 1994 1997 Employee Stock Purchase Plan 333-21963 February 18, 1997
SMITH, LANGE & PHILLIPS, LLP San Francisco July 28, 1998 EX-27 6 EXHIBIT 27
5 3-MOS DEC-31-1998 JAN-01-1998 MAR-31-1998 26,517 57,880 69,100 (2,724) 7,009 169,000 87,522 (23,657) 504,288 88,297 0 0 0 466 372,698 504,288 86,323 86,323 0 80,108 0 0 169 6,582 (2,315) 4,267 0 0 0 4,267 0.09 0.09
EX-27.1 7 EXHIBIT 27.1
5 3-MOS DEC-31-1997 JAN-01-1997 MAR-31-1997 18,407 10,730 51,438 (1,410) 4,572 90,098 53,988 (19,554) 279,862 52,371 0 0 0 395 202,885 279,862 60,821 60,821 0 56,547 0 0 318 4,609 (1,955) 2,654 0 0 0 2,654 0.07 0.06
EX-27.2 8 EXHIBIT 27.2
5 YEAR DEC-31-1997 JAN-01-1997 DEC-31-1997 29,650,074 82,925,569 76,273,581 (1,858,116) 4,999,384 201,628,900 72,404,115 (21,159,892) 496,313,084 88,873,555 0 0 0 454,504 339,793,276 496,313,084 298,671,286 298,671,286 0 285,158,712 0 0 785,840 44,050,009 (16,425,789) 27,624,220 0 0 0 27,624,789 0.65 0.62
EX-27.3 9 EXHIBIT 27.3
5 YEAR DEC-31-1996 JAN-01-1996 DEC-31-1996 18,564,566 16,448,759 46,444,294 (1,442,951) 4,591,893 89,933,711 50,634,959 (17,581,366) 277,614,321 61,279,090 0 0 0 379,744 182,144,326 277,614,321 217,874,341 217,874,341 0 194,111,180 0 0 1,296,451 (24,571,677) 9,134,724 15,436,953 0 0 0 15,436,953 0.42 0.40
EX-27.4 10 EXHIBIT 27.4
5 YEAR DEC-31-1995 JAN-01-1995 DEC-31-1995 6,487,207 30,734,519 32,346,675 (1,635,043) 3,816,432 77,131,062 34,974,737 (11,384,207) 187,744,274 38,261,437 0 0 0 355,204 138,548,799 187,744,274 137,717,449 137,717,449 0 132,327,070 0 0 2,623,269 4,168,674 (355,871) 3,812,803 0 0 0 3,812,803 0.15 0.14
EX-99.1 11 EXHIBIT 99.1 EXHIBIT 99.1 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS OVERVIEW Sylvan generates revenues from its three divisions: Sylvan Learning Centers, Sylvan Prometric and Sylvan Contract Educational Services. The following data are derived from the Company's supplemental consolidated financial statements.
THREE MONTHS YEAR ENDED DECEMBER 31, ENDED MARCH 31, -------------------------- --------------- 1995 1996 1997 1997 1998 -------- -------- -------- ------- ------- (IN THOUSANDS) Revenues: Sylvan Learning Centers........... $ 26,063 $ 36,799 $ 44,289 $ 9,231 $12,136 Sylvan Prometric.................. 61,224 122,889 187,800 34,016 47,567 Sylvan Contract Educational Services......................... 50,430 58,186 66,582 17,574 26,620 -------- -------- -------- ------- ------- Total revenues.................. $137,717 $217,874 $298,671 $60,821 $86,323 ======== ======== ======== ======= ======= Direct costs: Sylvan Learning Centers........... $ 18,675 $ 25,557 $ 36,708 $ 6,829 $ 9,429 Sylvan Prometric.................. 56,446 106,426 166,318 30,589 44,538 Sylvan Contract Educational Services......................... 47,685 53,373 56,057 16,168 22,814 -------- -------- -------- ------- ------- Total direct costs.............. $122,806 $185,356 $259,083 $53,586 $76,781 ======== ======== ======== ======= =======
RESULTS OF OPERATIONS Comparison of results for the quarter ended March 31, 1998 to results for the quarter ended March 31, 1997. Revenues. Total revenues increased by $25.5 million, or 42%, from $60.8 million in the first quarter of 1997 to $86.3 million in the first quarter of 1998. This increase resulted from higher revenues in all three divisions. Sylvan Learning Centers revenues increased by $2.9 million, or 32%, from $9.2 million in the first quarter of 1997 to $12.1 million in the first quarter of 1998. Franchise royalties increased by $500,000, or 17%, from $3.0 million in the first quarter of 1997 to $3.5 million in the first quarter of 1998. This increase in franchise royalties was due to an overall 14% increase in revenues at Learning Centers open for more than one year as of March 31, 1997, as well as royalties generated from a net of 29 Learning Centers opened after March 31, 1997. Franchise sales fees decreased by $500,000, or 71%, from $700,000 in the first quarter of 1997 to $200,000 in the first quarter of 1998. In the first quarter of 1998, the Company sold four franchise territories but no area development agreements, compared to five franchise territories sold and one $500,000 area development agreement sold in the first quarter of 1997. Revenues from Company-owned Learning Centers increased by $2.0 million, or 40%, from $5.0 million in the first quarter of 1997 to $7.0 million in the first quarter of 1998. The Company's acquisition of 13 Learning Centers from several franchisees after March 31, 1997 generated $1.5 million of the increase, with the remaining increase of $500,000 generated by Company- owned Learning Centers open for more than one year as of March 31, 1998. Product sales to franchisees increased by $400,000, or 57%, from $700,000 in the first quarter of 1997 to $1.1 million in the first quarter of 1998. The remaining increase in Sylvan Learning Centers revenues consisted of other franchise service income. Sylvan Prometric revenues increased by $13.6 million, or 40%, from $34.0 million in the first quarter of 1997 to $47.6 million in the first quarter of 1998. Block Testing Services, L.P. and related entities (collectively, "NAI/Block"), purchased during the fourth quarter of 1997, accounted for $3.1 million of the revenue growth. Revenues at ASPECT increased by $2.1 million, or 24%, as a result of volume growth. Excluding the NAI/Block and ASPECT acquisitions, revenue growth would have been 25%. Academic admissions testing revenues 1 increased by $3.5 million, or 97%, due to volume increases under the ETS contracts. The Test of English as a Foreign Language (the "TOEFL"), in its initial pilot phase, and the Graduate Management Admission Test (the "GMAT") were first offered through Sylvan Prometric beginning in the Fall of 1997. IT and professional certification testing revenues increased $3.8 million and $700,000, or 33% and 15%, respectively, primarily due to volume increases. Revenues at Wall Street decreased because Wall Street did not record any master franchise sales in the first quarter of 1998, compared to $1.2 million of master franchise sales recorded in the first quarter of 1997. Sylvan Contract Educational Services revenues increased by $9.0 million, or 51%, from $17.6 million in the first quarter of 1997 to $26.6 million in the first quarter of 1998. The increase in revenues included $6.7 million in revenues from Canter, which was purchased on January 1, 1998. The balance of the increase in revenues consisted of a $1.9 million increase in revenues from public and non-public school contracts and a $400,000 increase in revenues from PACE services. Revenues from public and non-public school contracts obtained after March 31, 1997 contributed $2.9 million to the increase in revenues for the first quarter of 1998. The first quarter of 1997 included $1.0 million of revenues from non-education related activity at Educational Inroads which was disposed of after the Educational Inroads acquisition on May 30, 1997. Revenues from public and non-public school contracts that existed in the first quarters of both 1997 and 1998 remained constant. Costs and Expenses. Total direct costs increased by $23.2 million, or 43%, from $53.6 million in the first quarter of 1997 to $76.8 million in the first quarter of 1998. Total direct costs increased as a percentage of total revenues from 88% to 89%. Sylvan Learning Centers expenses increased by $2.6 million, or 38%, from $6.8 million in the first quarter of 1997 to $9.4 million in the first quarter of 1998. As a percentage of Sylvan Learning Centers revenues, these expenses increased from 74% to 78%. The Company incurred $400,000 for the one-time development of several educational programs in the first quarter of 1998. Excluding these one-time expenses, Sylvan Learning Centers expenses would have been 74% of Sylvan Learning Centers revenues for the first quarter of 1998. Company-owned Learning Center expenses increased by $1.6 million, or 37%, primarily as a result of advertising and higher labor costs associated with increased enrollment. As a percentage of revenues, expenses at Company-owned Learning Centers decreased from 88% to 85%. Sylvan Prometric expenses increased by $14.0 million, or 46%, from $30.6 million in the first quarter of 1997 to $44.5 million in the first quarter of 1998. As a percentage of Sylvan Prometric revenues, Sylvan Prometric's expenses increased from 90% to 93%. The dollar increase was consistent with the increase in revenues from the first quarter of 1997. Excluding master franchise sales at Wall Street in the first quarter of 1997, Sylvan Prometric expenses would have remained constant at 93% of Sylvan Prometric revenues. Sylvan Contract Educational Services expenses increased by $6.6 million, or 41%, from $16.2 million in the first quarter of 1997 to $22.8 million in the first quarter of 1998. As a percentage of Sylvan Contract Educational Services revenues, these expenses declined from 92% to 86%. The increase in Sylvan Contract Educational Services expenses resulted from a $6.3 million increase in costs from PACE and Canter and a $300,000 increase in costs from public and non-public school contracts. The margin improvement at Sylvan Contract Educational Services was the result of the Company's ability to leverage increasing student volumes over the fixed cost infrastructure of this division. General and administrative expenses increased by $300,000, or 10%, from $3.0 million in the first quarter of 1997 to $3.3 million in the first quarter of 1998. As a percentage of revenues, these expenses decreased from 5% to 4% due to increased revenues without corresponding increases in administrative staff and overhead. Income before income taxes increased by $2.0 million, or 43%, from $4.6 million in the first quarter of 1997 to $6.6 million in the first quarter of 1998. These amounts include pre-tax losses of $1.1 million and $1.9 million in the first quarter of 1997 and 1998, respectively. The effective tax rate decreased from 42% in the first quarter of 1997 to 35% in the first quarter of 1998 mainly due to the effect of higher earnings in foreign countries with lower tax rates than the U.S. 2 Comparison of results for the year ended December 31, 1997 to the year ended December 31, 1996. Revenues. Total revenues increased by $80.8 million, or 37%, from $217.9 million in 1996 to $298.7 million in 1997. This increase resulted from higher revenues in all three divisions. Sylvan Learning Centers revenues increased by $7.5 million, or 20%, from $36.8 million in 1996 to $44.3 million in 1997. Franchise royalties increased by $1.9 million, or 20%, from $9.3 million in 1996 to $11.2 million in 1997. This increase in franchise royalties was due to an overall 10% increase in revenues at Learning Centers open for more than one year as of December 31, 1996, as well as royalties generated from a net of 60 Learning Centers opened in 1997. Franchise sales fees increased by $1.3 million, or 41%, from $3.2 million in 1996 to $4.5 million in 1997. In 1997, the Company sold six area development agreements for $2.9 million and 42 franchise Learning Center licenses, compared to four area development agreements sold for $1.7 million and 38 franchise Learning Center licenses sold in 1996. Revenues from Company- owned Learning Centers increased by $4.2 million, or 23%, from $18.5 million in 1996 to $22.7 million in 1997, primarily as a result of student enrollment increases at Learning Centers open for more than one year as of December 31, 1996 and, to a lesser extent, the Company's acquisition in 1997 of 13 Learning Centers from five franchises. Product sales to franchisees decreased by $190,000, or 5%, from $3.9 million in 1996 to $3.7 million in 1997. Sylvan Prometric revenues increased by $64.9 million, or 53%, from $122.9 million in 1996 to $187.8 million in 1997. Wall Street, purchased in December 1996, accounted for $19.0 million of the revenue growth. Revenues at ASPECT increased by $16.5 million, or 46%, as a result of volume growth. The remaining increase in Sylvan Prometric revenues resulted from increased services under ETS contracts, which included the cost-plus international contract, the Graduate Record Examination (the "GRE"), the GMAT and the TOEFL, certain volume-based pricing adjustments and testing in the IT and professional license businesses. Sylvan Contract Educational Services revenues increased by $8.4 million, or 14%, from $58.2 million in 1996 to $66.6 million in 1997. Revenues from PACE contracts accounted for $6.2 million of the increase for 1997, primarily as a result of contracts with new customers. Revenues from public and non-public school contracts increased by $2.2 million in 1997, primarily as a result of contracts with new school districts. Revenues from public and non-public school contracts obtained after December 31, 1996 contributed $5.3 million to the increase in revenues in 1997, while revenues from existing public and non- public school contracts obtained before December 31, 1996 decreased by $3.1 million in 1997, primarily due to reduced funding in some school districts and the expiration of several contracts in 1997. Costs and Expenses. Total direct costs increased by $73.7 million, or 40%, from $185.4 million in 1996 to $259.1 million in 1997. Total direct costs increased as a percentage of total revenues from 85% to 87% primarily as a result of non-recurring expenses of $21.5 million included in direct costs in 1997, as discussed below. Total direct costs in 1997 also include $5.4 million of non-recurring expenses related to accounting for the ASPECT acquisition as a pooling-of-interests. Excluding these non-recurring expenses, total direct costs as a percentage of total revenues would have been 78% in 1997. Sylvan Learning Centers expenses increased by $11.2 million, or 44%, from $25.6 million in 1996 to $36.7 million in 1997. As a percentage of Sylvan Learning Centers revenues, these expenses increased from 70% to 83%. Advertising expenses in 1997 included the Company's one-time $5.0 million contribution of Common Stock to a not-for-profit corporation whose sole purpose is to develop and fund advertising programs for the Sylvan Learning Centers. Franchise services expenses increased by $8.0 million, or 84%, from $9.5 million in 1996 to $17.5 million in 1997 and increased as a percentage of franchise-related revenues from 52% in 1996 to 82% in 1997. The lower margin in franchise services was primarily due to the one-time expense discussed above, as well as costs incurred for development of new programs and additional management staff for Sylvan Learning Centers. Company-owned Learning Center expenses increased by $3.1 million, or 19%, from $16.1 million in 1996 to $19.2 million in 1997 but decreased as a percentage of Company- owned Learning Center revenues from 87% to 85%. Expenses at Learning Centers operating for more than one year as of December 31, 1996 accounted for $2.0 million of the increase for 1997. The increase also resulted from $1.1 million of expenses associated with the 13 Learning Centers acquired from franchisees in 1997 and increases in advertising, labor and general overhead expenses associated with increased Learning Center enrollment. 3 Sylvan Prometric expenses increased by $59.9 million, or 56%, from $106.4 million in 1996 to $166.3 million in 1997. As a percentage of Sylvan Prometric revenues, these expenses increased from 87% to 89%. The increase in Sylvan Prometric expenses as a percentage of Sylvan Prometric revenues was primarily the result of one-time marketing expenses of $10.0 million resulting from the Company's contribution to IT Training Marketing Company, a not-for-profit corporation whose sole purpose is to fund promotional and channel support programs for Sylvan Prometric. The 1996 expenses included $2.4 million of non- recurring charges related to the Drake acquisition, incurred during the first and second quarters of 1996. Excluding these one-time charges, Sylvan Prometric expenses as a percentage of Sylvan Prometric revenues for 1996 and 1997 would have been 85% and 83%, respectively. This decrease in recurring Sylvan Prometric expenses as a percentage of Sylvan Prometric revenues was primarily due to the fixed expenses of the division being spread over a higher revenue base, as well as the effect of a full year of results of Wall Street, which generates higher incremental margins, in 1997 compared to only one month of results in 1996. Sylvan Contract Educational Services expenses increased by $2.7 million, or 5%, from $53.4 million in 1996 to $56.1 million in 1997. As a percentage of Sylvan Contract Educational Services revenues, these expenses decreased from 92% to 84%. Operating expenses for public and non-public school contracts decreased by $1.3 million, while operating expenses for PACE increased by $3.5 million. The decrease in Sylvan Contract Educational Services expenses as a percentage of revenues was the result of increased profit margins at PACE and public and non-public services in 1997, as well as a higher mix of revenues from PACE contracts which generate a higher profit margin than public and non- public services. In March 1998, the additional contingent consideration payable to the former shareholders of PACE was determined to be $25.8 million, which was recorded as additional goodwill and will be amortized over the estimated remaining useful life of 22 years. This amount will increase the amount of amortization generated by the Sylvan Contract Educational Services division by $1.2 million in 1998. General and administrative expenses increased by $13.3 million, or 151%, from $8.8 million in 1996 to $22.1 million in 1997 and increased as a percentage of total revenues from 4% in 1996 to 7% in 1997. Included in general and administrative expenses are one-time expenses of $9.7 million relating to a contribution of $6.5 million of Common Stock to Sylvan Learning Foundation, Inc., a not-for-profit foundation formed to promote various educational projects and a $3.2 million contribution to International Education Forum, Inc., a not-for-profit foundation formed to provide language programs for international students in the United States. Excluding these one- time expenses, general and administrative expenses would have been 4% of total revenues in 1997. In March 1997, the Company and NEC executed a definitive agreement, under which the Company was to acquire NEC. In May 1997, NEC accepted a competing offer which resulted in the termination of NEC's agreement with the Company. As a result, NEC paid the Company a $30.0 million termination fee, which has been recorded, net of $1.5 million of transaction costs (the "NEC Termination Fee"), as a separate component of non-operating income. In May 1997, the Company determined that certain computer hardware and software of Sylvan Prometric were impaired as a result of certain strategic changes in technical requirements and specifications made in connection with the Company's pursuing the NEC acquisition. During and after the negotiations with NEC, the Company developed plans that resulted in required changes in software systems and hardware utilized in Sylvan Prometric's network of testing centers. The plans continued to be valid for the Company even after the termination of the NEC acquisition. The Company determined the amount of the impairment loss by evaluating the likely sales proceeds from the disposition of the assets, compared to their book value. The Company determined that it was unlikely that the net cash proceeds from the sale of any assets would be significant and recorded an impairment loss equal to the $4.0 million net book value of the assets. 4 Investment and other income increased by $3.1 million, or 182%, from $1.7 million in 1996 to $4.8 million in 1997, primarily due to $2.0 million of non- cash dividend income received from the Company's investment in JLC Holdings, Inc. and the higher cash and investment balances resulting from the NEC Termination Fee and the net proceeds from the public sale of Common Stock during 1997. Interest expense decreased by $500,000 due to the repayment of all outstanding debt of Educational Inroads in the second quarter of 1997. The Company reported net losses of $2.0 million in 1997 from its investment in affiliates, consisting primarily of $1.4 million attributable to Caliber. The effective tax rate remained constant at 37% in 1996 and 1997. Comparison of results for the year ended December 31, 1996 to the year ended December 31, 1995. Revenues. Total revenues increased by $80.2 million, or 58%, from $137.7 million in 1995 to $217.9 million in 1996. This increase resulted from greater revenues in all three divisions. Sylvan Learning Centers revenues increased by $10.7 million, or 41%, from $26.1 million in 1995 to $36.8 million in 1996. Franchise royalties increased by $2.0 million, or 22%, from $9.2 million in 1995 to $11.2 million in 1996. This increase in franchise royalties was due to an overall 19% increase in revenues at Learning Centers that had been operating for more than one year as of December 31, 1995, as well as royalties from a net of 49 Learning Centers opened in 1996. Franchise sales fees increased by $1.1 million, or 52%, from $2.1 million in 1995 to $3.2 million in 1996. In 1996, the Company sold four area development agreements for $1.7 million and 38 franchise Learning Center licenses, compared to two area development agreements sold for $550,000 and 43 franchise Learning Center licenses sold during 1995. Revenues from Company- owned Learning Centers increased by $7.0 million, or 61%, from $11.5 million in 1995 to $18.5 million in 1996. Revenue growth related to increased student enrollment at Learning Centers that had been operating for more than one year as of December 31, 1995 resulted in $3.4 million, or 49%, of the increase from 1995 to 1996. Approximately $3.2 million of the revenue increase resulted from the acquisition of 11 Learning Centers from two franchisees during 1996, and the opening of one new Learning Center during 1996 resulted in an additional $350,000 of revenues. Product sales to franchisees increased by $700,000, or 22%, from $3.2 million in 1995 to $3.9 million in 1996. This increase resulted from overall student enrollment increases at franchised Learning Centers. Sylvan Prometric revenues increased by $61.7 million, or 101%, from $61.2 million in 1995 to $122.9 million in 1996. This significant increase in Sylvan Prometric revenues resulted primarily from the September 1995 acquisition of Drake, which provided increased revenues from IT clients. Increased services under ETS contracts, including the cost-plus international contract and the GRE, and other professional testing revenues increases, including NASD testing, which began in February 1996, also contributed to the increase in Sylvan Prometric revenues. In addition, revenues at ASPECT increased by $9.3 million, or 35%, as a result of volume growth. Sylvan Contract Educational Services revenues increased by $7.8 million, or 15%, from $50.4 million in 1995 to $58.2 million in 1996. Revenues from public and non-public school contracts accounted for $5.9 million of the increase, and greater revenues from PACE accounted for $1.9 million of the increase. The PACE increase primarily resulted from the fact that the acquisition, accounted for as a purchase, was effective February 28, 1995, and, therefore, the division's 1995 revenues only reflect ten months of PACE revenues. Revenues from public and non-public school contracts begun during 1996 contributed $2.2 million to 1996 revenues. Revenues from public and non-public school contracts begun during 1995 increased by $4.6 million in 1996, primarily because a full year of revenues were generated under these contracts during 1996. Costs and Expenses. Total direct costs increased by $62.6 million, or 51%, from $122.9 million in 1995 to $185.3 million in 1996 but decreased as a percentage of total revenues from 89% to 85%. 5 Sylvan Learning Centers expenses increased by $6.9 million, or 37%, from $18.7 million in 1995 to $25.6 million in 1996. Franchise services expenses increased by $600,000, or 10%, from $5.9 million in 1995 to $6.5 million in 1996 but decreased as a percentage of franchise royalties and sales revenues from 64% in 1995 to 58% in 1996. The higher margin in 1996 related primarily to the effects of leveraging the fixed costs of supporting this division over a larger revenue base. Company-owned Learning Center expenses increased by $5.7 million, or 55%, from $10.4 million in 1995 to $16.1 million in 1996 but decreased as a percentage of Company-owned Learning Center revenues from 90% in 1995 to 87% in 1996. Of the increase, $3.1 million related to the acquisition of 11 Learning Centers. The remaining increase resulted primarily from advertising, labor and general overhead expenses associated with increased enrollment at Company-owned Learning Centers acquired prior to 1996. Sylvan Prometric expenses increased by $50.0 million, or 89%, from $56.4 million in 1995 to $106.4 million in 1996 but decreased as a percentage of Sylvan Prometric revenues from 92% in 1995 to 87% in 1996. The increased expenses resulted primarily from the acquisition of Drake and increased registration and delivery costs associated with an increased volume of tests delivered. Sylvan Prometric expenses in 1996 included $2.4 million of amortization of contract rights related to the Drake acquisition. Sylvan Prometric expenses in 1995 included $4.1 million of amortization of contract rights, imputed interest and salary termination charges related to the Drake acquisition. Excluding these non-recurring charges, Sylvan Prometric expenses as a percentage of Sylvan Prometric revenues would have remained constant at 85% in 1995 and 1996. Sylvan Contract Educational Services expenses increased by $5.7 million, or 12%, from $47.7 million in 1995 to $53.4 million in 1996 but decreased as a percentage of Sylvan Contract Educational Services revenues from 95% in 1995 to 92% in 1996. The decline in these expenses as a percentage of Sylvan Contract Educational Services revenues resulted from increased revenues without corresponding increases in overhead. Operating expenses for public and non-public school contracts increased $4.6 million during 1996, while operating expenses for PACE increased $1.1 million. The PACE increase resulted from the fact that the acquisition, accounted for as a purchase, was effective February 28, 1995, and therefore, the 1995 results include only ten months of PACE results. General and administrative expenses increased by $2.6 million, or 41%, from $6.2 million in 1995 to $8.8 million in 1996 but decreased as a percentage of total revenues from 5% in 1995 to 4% in 1996. The percentage decline resulted from increased revenues in all divisions without corresponding increases in overhead. The Company incurred $1.6 million of net interest expense in 1995 and generated $400,000 of net interest income in 1996. This change resulted primarily from $1.1 million of imputed interest expense on the purchase of Drake in 1995 and an increase in the average invested cash amounts in 1996 compared to 1995. The effective tax rate increased from 9% in 1995 to 37% in 1996. This increase was primarily the result of a 1995 decrease in the amount of the valuation allowance for deferred tax assets, consisting principally of net operating loss carryforwards. LIQUIDITY AND CAPITAL RESOURCES Cash provided by operating activities was $13.6 million for first quarter of 1998 compared to $500,000 in the first quarter of 1997. $9.5 million of the increase in operating cash flow was attributable to a decrease in accounts and notes receivable, including the collection of a $7.0 million receivable from IT Training Marketing Company related to the purchase of Common Stock by IT Training Marketing Company. Cash provided by operating activities increased by $29.1 million, or 100%, from $29.0 million in 1996 to $58.1 million in 1997. This increase was primarily attributable to a $33.9 million increase in income before non-cash charges and the $28.5 million net cash effect of the NEC Termination Fee. Cash flow from operations was 6 also favorably affected by $18.2 million of increases in accounts payable, accrued expenses and income taxes payable, consistent with the Company's higher volume of business. Management believes that Sylvan's investment in working capital will continue to reduce net cash flow from operations, particularly as a result of growth in accounts and notes receivable, consistent with the Company's higher volume of business. Increases in domestic and international testing volumes have resulted in significant increases in accounts receivable from ETS. ETS typically makes monthly payments for domestic activity and quarterly payments for international services. Accounts receivable from public school-based programs have increased due to billings under new contracts. Sylvan believes that uncollectible accounts receivable will not have a significant effect on future liquidity, as a significant portion of its accounts receivable are due from entities with substantial financial resources. The Company's investing activities consist primarily of acquisitions of businesses, acquisitions of property and equipment and the temporary investment of excess cash in available-for-sale securities. During the first quarter of 1998, the Company acquired Canter for a net cash purchase price of $24.3 million. During 1997, the Company's investments increased by $66.5 million to $82.9 million, primarily as a result of the investment of the net proceeds received by the Company from the public sale of Common Stock in 1997. These investments are readily marketable and available for use in current operations. In 1997, the Company also made $9.7 million of additional investments or loans to affiliates accounted for using the equity method, primarily Caliber. In January 1997, the Company acquired Wall Street for $4.7 million in cash, including acquisition costs. The Company continues to incur expenditures for additions to property and equipment, which totaled $14.6 million in the first quarter of 1998 and $30.9 million in 1997. These additions consist primarily of furniture and equipment for general business expansion, including expenditures related to new public and non-public school contracts, testing center expansions, equipment upgrades, internal software development and equipment needed for overseas testing centers operated by the Company under the ETS international testing contract. Under this international contract with ETS, the Company is reimbursed for overseas equipment expenditures as the equipment is depreciated. This reimbursement includes a financing charge over the reimbursement period. The Company had entered into a loan agreement with a bank (the "Credit Line") that provided an unsecured revolving line of credit allowing the Company to borrow a maximum of $15.0 million. The Credit Line expired on May 31, 1998. The Credit Line bore interest at a floating rate equal to the 30-day London Interbank Offered Rate ("LIBOR") plus 1.15% per annum (5.69% at March 31, 1998). The Credit Line had no outstanding borrowings at December 31, 1997 or March 31, 1998. The Company is in the process of obtaining a new line of credit which it believes will contain substantially the same terms as the Credit Line. The Company was required to make cash payments of $13.6 million in 1998 to the former shareholders of PACE as contingent consideration. This amount was classified as a current liability at December 31, 1997 and March 31, 1998, and was paid in April 1998. Also, as of December 31, 1997, the Company was obligated to issue Common Stock with a value of $56.4 million to shareholders of PACE, Drake and other acquired companies. This amount was classified as a long-term liability at March 31, 1998 and December 31, 1997, and shares valued at $31.5 million were issued in the second quarter of 1998. The Company had $5.1 million and $3.5 million, respectively, of long-term debt outstanding at March 31, 1998 and December 31, 1997. Upon the acquisition of Drake in September 1995, the Company entered into two contingent payment obligations related to the acquisition. The first related to 2,678,571 shares of Common Stock (the "Revenue Escrow Shares") that were placed in escrow to be released to the sellers provided certain revenue targets relating to portions of the computer-based testing business are achieved from 1996 through 1998. Based on testing revenues in 1996 and 1997, 60% of the Revenue Escrow Shares had been earned through December 31, 1997. As of December 31, 1997, an additional $28.2 million of goodwill related to the earned shares was recorded and will be amortized over the remaining estimated useful life. 535,715 and 1,071,429 Revenue Escrow Shares were released to the sellers in 1997 and 1998, respectively. 7 The sellers of Drake may receive up to an additional $40.0 million (payable 12.5% in cash and the balance in either cash or restricted shares of Common Stock, at the Company's option) as a second component of contingent consideration. This component will be earned if other revenues targets relating to portions of the combined computer-based testing business are achieved in 1998 or 1999 (with the measuring year selected by the sellers). Long-term liabilities at March 31, 1998 and December 31, 1997 do not include any amount related to this component. Sylvan believes that its capital resources, including the net proceeds from the sale of the Notes, will be sufficient over at least the next several years to fund expected expansion of its business, including acquisitions, and its working capital needs. Sylvan continues to review other companies in the education or computer- based testing industries for potential acquisitions. Additional capital resources may be necessary to acquire and thereafter operate any acquired businesses. See "Use of Proceeds." EFFECTS OF INFLATION Inflation has not had a material effect on the Company's revenues and income in the past three years. QUARTERLY FLUCTUATIONS The Company's revenues and operating results have varied substantially from quarter to quarter and will continue to vary, depending upon the method of accounting for, and the costs and timing of completion and integration of, acquisitions and the timing of implementation of new computer-based testing contracts or new contracts funded under Title I or similar programs. Revenues generated by Sylvan Prometric are likely to vary based on the frequency and timing of delivery of individual tests and the speed of test administrators' conversion of tests to computer-based versions. Revenues or income in any period will not necessarily be indicative of results in subsequent periods. 8 EX-99.2 12 EXHIBIT 99.2 EXHIBIT 99.2 SUPPLEMENTAL CONSOLIDATED FINANCIAL STATEMENTS FOR THE YEARS ENDED DECEMBER 31, 1995, 1996, 1997 Report of Independent Auditors Supplemental Consolidated Balance Sheets as of December 31, 1996 and December 31, 1997 Supplemental Consolidated Statements of Income for the years ended December 31, 1995, 1996 and 1997 Supplemental Consolidated Statements of Stockholders' Equity for the years ended December 31, 1995, 1996 and 1997 Supplemental Consolidated Statements of Cash Flows for the years ended December 31, 1995, 1996 and 1997 Notes to Supplemental Consolidated Financial Statements Report of Independent Auditors The Board of Directors and Stockholders Sylvan Learning Systems, Inc. We have audited the supplemental consolidated balance sheets of Sylvan Learning Systems, Inc. (formed as a result of the consolidation of Sylvan Learning Systems, Inc. and Aspect International Language Schools, B.V. and subsidiaries) as of December 31, 1997 and 1996, and the related supplemental consolidated statements of income, stockholders' equity, and cash flows for each of the three years in the period ended December 31, 1997. The supplemental consolidated financial statements give retroactive effect to the merger of Sylvan Learning Systems, Inc. and Aspect International Language Schools, B.V. and subsidiaries on May 6, 1998, which has been accounted for using the pooling-of-interests method as discussed in the notes to the supplemental consolidated financial statements. These supplemental financial statements are the responsibility of the management of Sylvan Learning Systems, Inc. Our responsibility is to express an opinion on these supplemental financial statements based on our audits. We did not audit the 1996 and 1995 combined financial statements of I-R, Inc. and Independent Child Study Teams, Inc., or the financial statements of Aspect, Inc. and Anglo World Education Limited and subsidiaries, each wholly owned subsidiaries. These statements reflect total assets of $17,198,487 and $21,071,892 as of December 31, 1997 and 1996, respectively, and total revenues of $35,613,484, $48,152,198 and $41,808,740 for the years ended December 31, 1997, 1996, and 1995, respectively. These statements were audited by other auditors whose reports have been furnished to us, and our opinion, insofar as it relates to data included for these subsidiaries, is based solely on the reports of the other auditors. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits and the reports of other auditors provide a reasonable basis for our opinion. In our opinion, based on our audits and the reports on other auditors, the supplemental financial statements referred to above present fairly, in all material respects, the consolidated financial position of Sylvan Learning Systems, Inc. at December 31, 1997 and 1996, and the consolidated results of its operations and its cash flows for each of the three years in the period ended December 31, 1997, after giving retroactive effect to the merger of Aspect International Language Schools, B.V. and subsidiaries as described in the notes to the supplemental consolidated financial statements, in conformity with generally accepted accounting principles. /s/ ERNST & YOUNG LLP Baltimore, Maryland July 28, 1998 Sylvan Learning Systems, Inc. and Subsidiaries Supplemental Consolidated Balance Sheets
December 31, December 31, 1996 1997 --------------- --------------- (Restated-Note 1) (Restated-Note 1) Assets Current assets: Cash and cash equivalents $ 18,564,566 $ 29,650,074 Available-for-sale securities 16,448,759 82,925,569 Receivables: Accounts receivable 39,250,493 60,679,361 Costs and estimated earnings in excess of billings on uncompleted contracts 3,565,201 3,899,760 Notes receivable 3,007,473 2,942,861 Other receivables 621,127 8,751,599 ------------- ------------- 46,444,294 76,273,581 Allowance for doubtful accounts (1,442,951) (2,508,116) ------------- ------------- 45,001,343 73,765,465 Inventory 4,591,893 4,999,384 Deferred income taxes 619,553 3,737,831 Prepaid expenses and other current assets 4,707,597 6,550,577 ------------- ------------- Total current assets 89,933,711 201,628,900 Notes receivable, less current portion 562,989 6,231,651 Costs and estimated earnings in excess of billings on uncompleted contracts, less current portion 549,448 351,712 Property and equipment: Land and buildings 4,518,994 5,710,227 Furniture and equipment 40,480,430 58,709,241 Leasehold improvements 5,635,535 7,984,647 ------------- ------------- 50,634,959 72,404,115 Accumulated depreciation (17,581,366) (21,159,892) ------------- ------------- 33,053,593 51,244,223 Intangible assets: Goodwill 104,478,407 183,004,277 Contract rights 13,881,337 13,972,800 Other 2,570,091 2,522,391 ------------- ------------- 120,929,835 199,499,468 Accumulated amortization (10,786,422) (16,714,130) ------------- ------------- 110,143,413 182,785,338 Deferred contract costs, net of accumulated amortization of $2,066,893 as of December 31, 1996 and $6,205,393 as of December 31, 1997 13,230,340 10,323,898 Investments in and advances to affiliates 5,895,602 12,463,729 Other investments 22,219,888 28,017,457 Other assets 2,025,337 3,266,176 ------------- ------------- Total assets $ 277,614,321 $ 496,313,084 ============= =============
See accompanying notes. Sylvan Learning Systems, Inc. and Subsidiaries Supplemental Consolidated Balance Sheets
December 31, December 31, 1996 1997 ---------------- --------------- (Restated-Note 1) (Restated-Note 1) Liabilities and stockholders' equity Current liabilities: Accounts payable and accrued expenses $ 30,882,871 $ 40,706,949 Income taxes payable 309,723 5,590,358 Current portion of long-term debt 3,331,057 1,212,860 Current portion of due to shareholders of acquired companies 4,920,565 13,794,195 Deferred revenue 19,360,961 26,288,930 Other current liabilities 2,473,913 1,280,263 ------------- ------------- Total current liabilities 61,279,090 88,873,555 Long-term debt, less current portion 4,261,754 2,303,164 Deferred income taxes 2,650,515 7,619,561 Due to shareholders of acquired companies, less current portion 26,525,855 56,365,578 Other long-term liabilities 373,037 903,446 Stockholders' equity: Preferred stock, par value $.01 per share--authorized 10,000,000 shares, no shares issued and outstanding as of December 31, 1997 and 1996 -- -- Common stock, par value $.01 per share--authorized 90,000,000 shares, issued and outstanding shares of 37,974,353 as of December 31, 1996 and 45,450,447 as of December 31, 1997 379,744 454,504 Additional paid-in capital 169,078,155 301,896,979 Retained earnings 13,247,697 39,057,274 Unrealized losses on available for sale securities (11,043) -- Foreign currency translation adjustments (170,483) (1,160,977) ------------- ------------- Total stockholders' equity 182,524,070 340,247,780 ------------- ------------- Total liabilities and stockholders' equity $ 277,614,321 $ 496,313,084 ============= =============
See accompanying notes. Sylvan Learning Systems, Inc. and Subsidiaries Supplemental Consolidated Statements of Income
Year Ended December 31, ------------------------------------------------------ 1995 1996 1997 ------------------------------------------------------ (Restated-Note 1) (Restated-Note 1) (Restated-Note 1) Revenues $ 137,717,449 $ 217,874,341 $ 298,671,286 Cost and expenses: Direct costs 122,806,049 185,355,774 259,082,849 General and administrative expense 6,205,480 8,755,406 22,075,863 Loss on impairment of assets 3,315,541 -- 4,000,000 ------------- ------------- ------------- Total expenses 132,327,070 194,111,180 285,158,712 ------------- ------------- ------------- Operating income 5,390,379 23,763,161 13,512,574 Other income (expense): Termination fee, net of direct costs -- -- 28,500,000 Investment and other income 1,011,050 1,743,662 4,829,539 Interest expense (2,623,269) (1,296,451) (785,840) Equity in net income (loss) of affiliates 390,514 361,305 (2,006,264) ------------- ------------- ------------- Income before income taxes 4,168,674 24,571,677 44,050,009 Income taxes (355,871) (9,134,724) (16,425,789) ------------- ------------- ------------- Net income 3,812,803 15,436,953 27,624,220 ------------- ------------- ------------- Earnings per common share, basic $ 0.15 $ 0.42 $ 0.65 ============= ============= ============= Earnings per common share, diluted $ 0.14 $ 0.40 $ 0.62 ============= ============= =============
See accompanying notes. Sylvan Learning Systems, Inc. and Subsidiaries Consolidated Statements of Stockholders' Equity
Retained Additional Earnings Common Paid-In (Accumulated Stock Capital Deficit) ----------- ------------- -------------- Balance at January 1, 1995, as restated $ 238,610 $ 39,429,754 $ (5,682,248) Options and warrants exercised for purchase of 1,097,807 shares of common stock 10,978 4,207,278 Issuance of 393,669 shares of common stock in connection with the acquisition of PACE 3,937 3,156,924 Issuance of 5,892,858 shares of common stock in connection with the acquisition of Drake 58,929 49,441,071 Issuance of 4,275,000 shares of common stock, net of offering costs of $3,367,266 42,750 44,089,984 Foreign currency translation adjustment Unrealized gain (loss) on available-for-sale securities Net income for 1995 3,812,803 ----------- ------------- ------------- Balance at December 31, 1995, as restated 355,204 140,325,011 (1,869,445) Options and warrants exercised for purchase of 992,550 shares of common stock, including income tax benefit of $1,887,006 9,925 6,988,118 Issuance of 1,236,000 shares of common stock in connection with the investment in Jostens Learning Corporation 12,360 21,205,640 Issuance of 174,908 shares of common stock in connection with other acquisitions 1,749 26,642 (319,811) Exercise of underwriter's overallotment option to purchase 50,625 shares of common stock in connection with 1995 public stock offering 506 532,744 Foreign currency translation adjustment Unrealized gain (loss) on available-for-sale securities Net income for 1996 15,436,953 ----------- ------------- ------------- Balance at December 31, 1996, as restated 379,744 169,078,155 13,247,697 Options and warrants exercised for purchase of 1,705,868 shares of common stock, including income tax benefit of $8,155,946 17,034 13,102,441 Issuance of 535,715 shares of common stock in connection with contingent consideration related to the acquisition of Drake 5,357 8,137,499 Issuance of 1,072,326 shares of common stock in connection with the acquisition of WSI 10,723 15,309,408 Issuance of 403,677 shares of common stock to Sylvan Learning Foundation as charitable contribution 4,037 6,536,963 Issuance of 308,823 shares of common stock to IT Training Marketing Company as marketing expense 3,088 6,996,912 Issuance of 264,705 shares of common stock to SLC National Advertising Fund, Inc. as advertising expense 2,647 4,997,353 Issuance of 3,093,438 shares of common stock for cash - net of offering costs of $3,645,455 30,934 73,659,561 Capital contribution by former shareholders of Educational Inroads 2,810,930 Distributions to former shareholders (1,814,643) Issuance of 93,843 shares of common stock in connection with other acquisitions 940 717,757 Stock options to purchase 316,500 shares of common stock granted to non-employees 550,000 Foreign currency translation adjustment Unrealized gain (loss) on available-for-sale securities Net income for 1997 27,624,220 ----------- ------------- ------------- Balance at December 31, 1997, as restated $ 454,504 $ 301,896,979 $ 39,057,274 =========== ============= ============= Unrealized Foreign Holding Currency Total Gains / Translation Stockholders' (Losses) Adjustments Equity ----------- ------------- ------------- Balance at January 1, 1995, as restated $ (19,846) $ -- $ 33,966,270 Options and warrants exercised for purchase of 1,097,807 shares of common stock 4,218,256 Issuance of 393,669 shares of common stock in connection with the acquisition of PACE 3,160,861 Issuance of 5,892,858 shares of common stock in connection with the acquisition of Drake 49,500,000 Issuance of 4,275,000 shares of common stock, net of offering costs of $3,367,266 44,132,734 Foreign currency translation adjustment 98,670 98,670 Unrealized gain (loss) on available-for-sale securities 14,409 14,409 Net income for 1995 3,812,803 ----------- ------------- ------------- Balance at December 31, 1995, as restated (5,437) 98,670 138,904,003 Options and warrants exercised for purchase of 992,550 shares of common stock, including income tax benefit of $1,887,006 6,998,043 Issuance of 1,236,000 shares of common stock in connection with the investment in Jostens Learning Corporation 21,218,000 Issuance of 174,908 shares of common stock in connection with other acquisitions (291,420) Exercise of underwriter's overallotment option to purchase 50,625 shares of common stock in connection with 1995 public stock offering 533,250 Foreign currency translation adjustment (269,153) (269,153) Unrealized gain (loss) on available-for-sale securities (5,606) (5,606) Net income for 1996 15,436,953 ----------- ------------- ------------- Balance at December 31, 1996, as restated (11,043) (170,483) 182,524,070 Options and warrants exercised for purchase of 1,705,868 shares of common stock, including income tax benefit of $8,155,946 13,119,475 Issuance of 535,715 shares of common stock in connection with contingent consideration related to the acquisition of Drake 8,142,856 Issuance of 1,072,326 shares of common stock in connection with the acquisition of WSI 15,320,131 Issuance of 403,677 shares of common stock to Sylvan Learning Foundation as charitable contribution 6,541,000 Issuance of 308,823 shares of common stock to IT Training Marketing Company as marketing expense 7,000,000 Issuance of 264,705 shares of common stock to SLC National Advertising Fund, Inc. as advertising expense 5,000,000 Issuance of 3,093,438 shares of common stock for cash - net of offering costs of $3,645,455 73,690,495 Capital contribution by former shareholders of Educational Inroads 2,810,930 Distributions to former shareholders (1,814,643) Issuance of 93,843 shares of common stock in connection with other acquisitions 718,697 Stock options to purchase 316,500 shares of common stock granted to non-employees 550,000 Foreign currency translation adjustment (990,494) (990,494) Unrealized gain (loss) on available-for-sale securities 11,043 11,043 Net income for 1997 27,624,220 ----------- ------------- ------------- Balance at December 31, 1997, as restated $ -- $ (1,160,977) $ 340,247,780 =========== ============= =============
See accompanying notes. Sylvan Learning Systems, Inc. and Subsidiaries Supplemental Consolidated Statements of Cash Flows
Years Ended December 31, --------------------------------------------------------- 1995 1996 1997 --------------------------------------------------------- (Restated- Note 1) (Restated- Note 1) (Restated- Note 1) Operating activities Net income $ 3,812,803 $ 15,436,953 $ 27,624,220 Adjustments to reconcile net income to net cash provided by (used in) operating activities: Depreciation 4,430,741 6,419,602 8,715,089 Amortization 4,328,244 7,484,633 10,062,521 Non-cash marketing and advertising expense - - 11,500,000 Interest imputed on purchase of Drake 1,125,000 - - Loss on impairment of assets 3,315,541 - 4,000,000 Non-cash dividend income - - (2,000,000) Provision for doubtful accounts (16,880) (49,181) 1,230,225 Deferred income taxes (413,254) 2,072,860 1,850,768 Equity in net (income) loss of affiliates (390,514) (361,305) 2,006,264 Non-cash issuance of options to non-employees - - 550,000 Gain on sale of property and equipment - - (651,481) Changes in operating assets and liabilities: Accounts and notes receivable (10,823,182) (10,237,293) (28,529,011) Cost and estimated earnings in excess of billings on uncompleted contracts (1,021,779) (412,910) (136,823) Inventory (1,597,788) (183,588) (399,674) Prepaid expenses and other current assets (1,410,053) (301,525) (1,887,041) Other assets (109,736) (997,608) (754,990) Accounts payable and accrued expenses (3,141,813) 5,635,694 18,224,249 Billings in excess of costs and estimated earnings on uncompleted contracts (455,600) (233,665) 120,350 Deferred revenue and other long-term liabilities 1,631,044 4,692,566 6,532,110 ------------- ------------- ------------- Net cash provided by (used in) operating activities (737,226) 28,965,233 58,056,776 ------------- ------------- ------------- Investing activities Purchase of available-for-sale securities (91,759,493) (31,261,415) (92,521,520) Proceeds from sale of available-for-sale securities 66,595,240 45,542,061 26,044,710 Investment in and advances to affiliates 24,782 (3,444,862) (9,653,085) Increase in other investments - (2,329,874) (4,136,250) Purchase of property and equipment (6,560,287) (14,840,119) (30,893,484) Proceeds from sale of property and equipment 2,411 10,964 1,915,837 Purchase of contract rights - (4,890,576) - Purchase of Drake Prometric, L. P., including direct costs of acquisition, net of cash received (16,979,737) - - Purchase of Wall Street Institute, including direct costs of acquisition, net of cash received - 2,012,565 (4,670,565) Cash paid for other acquired businesses, net of cash received (715) 570,069 (1,850,702) Expenditures for deferred contract costs and other assets (801,586) (6,941,769) (1,443,058) ------------- ------------- ------------- Net cash used in investing activities (49,479,385) (15,572,956) (117,208,117) ------------- ------------- ------------- Financing activities Payments on loans from stockholders of acquired companies (630,533) (37,604) (492,887) Proceeds from exercise of options and warrants 4,218,256 5,111,037 4,963,529 Proceeds from issuance of common stock 44,132,734 533,250 73,690,495 Proceeds from issuance of long-term debt 346,195 363,559 451,518 Payments on long-term debt and capital lease obligations (2,962,440) (2,758,726) (5,630,751) Distributions - - (481,779) Proceeds from bank lines of credit 4,600,000 200,000 13,575,297 Payments on bank lines of credit - (3,812,069) (14,575,297) ------------- ------------- ------------- Net cash provided by (used in) financing activities 49,704,212 (400,553) 71,500,125 ------------- ------------- ------------- Effects of exchange rate changes on cash 34,465 (914,365) (1,263,276) ------------- ------------- ------------- Net increase (decrease) in cash and cash equivalents (477,934) 12,077,359 11,085,508 Cash and cash equivalents at beginning of period 6,965,141 6,487,207 18,564,566 ------------- ------------- ------------- Cash and cash equivalents at end of period $ 6,487,207 $ 18,564,566 $ 29,650,074 ============= ============= =============
See accompanying notes. Sylvan Learning Systems, Inc. and Subsidiaries Notes to Supplemental Consolidated Financial Statements 1. Basis of Presentation and Description of Business Sylvan Learning Systems, Inc. and subsidiaries (the Company) is an international provider of educational and testing services. The Company conducts operations in three separate business segments - core educational services, testing services, and contract educational services. The core educational services segment designs and delivers individualized tutorial services to school-age children and adults through a network of 670 franchised and Company-owned Sylvan Learning Centers in operation in 49 states, five Canadian provinces, Hong Kong, Guam and South Korea. The Company's testing segment ("Sylvan Prometric") administers computer-based tests for major corporations, professional associations and governmental agencies through a network of certification centers which are located throughout the world. This segment also includes the operations of Wall Street Institute, a European-based franchisor and operator of learning centers that teach the English language through a combination of computer-based and live instruction, as well as the operations of Aspect International Language Schools, B.V. ("Aspect"). Aspect focuses principally on intensive English language instruction to students and professionals worldwide through its 19 language schools in five countries. The contract educational services segment provides educational programs to employees of large corporations and to public and non-public school districts through contracts funded by federal Title I and state-based programs. The consolidated financial statements include the accounts of Sylvan Learning Systems, Inc. and its wholly-owned subsidiaries. All intercompany accounts and transactions have been eliminated in consolidation. Investments in affiliates owned more than 20%, but not in excess of 50%, and corporate joint ventures are reported using the equity method. The preparation of the financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect reported amounts and related disclosures. Actual results could differ from those estimates. As discussed in Note 3, on May 6, 1998 the Company consummated its acquisition of all of the outstanding stock of Aspect. The acquisition has been accounted for as a pooling-of-interests and accordingly, the Company's financial statements have been restated to include the results of Aspect for all periods presented. As of the date of the issuance of these financial statements, the Company has not issued financial statements for a period including the merger date. Therefore, the accompanying consolidated financial statements are considered "supplemental." Upon the issuance of financial statements for a period that includes the date of the merger, the supplemental consolidated financial statements will become the historical consolidated financial statements of the Company. Sylvan Learning Systems, Inc. and Subsidiaries Notes to Supplemental Consolidated Financial Statements 1. Basis of Presentation and Description of Business (continued) The Company's fiscal year ends on December 31. The accounts of its wholly-owned subsidiary, Aspect, have been consolidated on the basis of a year ending on September 30. Such fiscal period corresponds with Aspect's natural business year. 2. Accounting Policies Cash Equivalents The Company considers all highly liquid investments with a maturity of three months or less when purchased to be cash equivalents. Investments Available-for-sale securities are carried at fair value, with the unrealized gains and losses, net of tax, reported in a separate component of stockholders' equity. The amortized cost of debt securities in this category is adjusted for amortization of premiums and accretion of discounts to maturity. Such amortization is included in investment income. Realized gains and losses and declines in value judged to be other than temporary on available-for-sale securities are included in investment income. The cost of securities sold is based on the specific identification method. Interest and dividends on securities classified as available-for-sale are included in investment income. Inventory Inventory, consisting primarily of computer software and educational, instructional, and marketing materials and supplies, is stated at the lower of cost (first-in, first-out) or market value. Property and Equipment Property and equipment is stated at cost. Depreciation is determined using the straight-line method over the estimated useful lives of the assets. Intangible Assets Goodwill consists of the cost in excess of fair value of the net assets of entities acquired in purchase transactions, and is amortized on a straight-line basis, over the estimated future periods to be benefited, which range from 10 to 25 years. At December 31, 1996 and 1997, accumulated Sylvan Learning Systems, Inc. and Subsidiaries Notes to Supplemental Consolidated Financial Statements amortization of goodwill was $4,853,789 and $8,788,445, respectively. 2. Accounting Policies (continued) Contract rights consist of the allocated cost of acquiring computer-based testing contracts in business combinations accounted for as purchases. Contract rights are being amortized on a straight-line basis, over the term of the related contract, which range from nine months to 10 years. At December 31, 1996 and 1997, accumulated amortization of contract rights was $5,193,199 and $6,898,966, respectively. Deferred Contract Costs Deferred contract costs include costs incurred to develop computer-based tests under contractual arrangements with customers. Under these arrangements, the Company incurs certain costs related to the development of new computer-based tests on behalf of the customer in return for the right to deliver the computer-based tests and collect a testing fee from either the candidate or the sponsoring organization. These costs are capitalized and amortized over the shorter of the estimated utility period of the test or the contractual period for delivery of the test. Deferred contract costs also include payments of approximately $10,400,000 made to non-affiliated computer-based testing centers that have entered into three-year contracts with the Company to deliver information technology computer-based certification tests. In accordance with the terms of these contracts, the independent testing centers have received an advance payment and will receive no additional fees upon delivery of the computer-based certification tests. These costs are being amortized over the contractual term of three years. Impairment of Long-Lived Assets Long-lived assets, including intangible assets, are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be fully recoverable. If an impairment indicator is present, the Company evaluates whether an impairment exists on the basis of undiscounted expected future cash flows from operations for the remaining amortization period. If an impairment exists, the asset is reduced by the estimated shortfall of discounted cash flows. Sylvan Learning Systems, Inc. and Subsidiaries Notes to Supplemental Consolidated Financial Statements 2. Accounting Policies (continued) Revenue Recognition Franchise sales fees relate to single-center and area franchise sales. Revenue related to these sales is recognized when all material services or conditions relating to the sales have been substantially performed or satisfied by the Company. For single-center franchise sales, the criteria for substantial performance include: (1) receipt of an executed franchise license agreement, (2) receipt of full payment of the franchise fee, (3) completion of requisite training by the franchisee or center director, and (4) completion of site selection assistance and site approval. Area franchise sales generally transfer to the licensee the right to develop and operate centers in a specified territory, primarily in a foreign country, and the Company's future obligations are insignificant. Area franchise fees are recognized upon the signing of the license agreement and the determination that (1) all material services or conditions relating to the sale have been satisfied and the fee is non-refundable, (2) a minimum payment of 50% of the fee is required within 90 days of the date of the agreement, and (3) the Company has the ability to estimate the collectability of any unpaid amounts. Franchise sales fees not meeting the recognition criteria are recorded as deferred revenue if not refundable, or deposits from franchisees if refundable. Commissions paid on sales of franchises are recorded as a current asset until the corresponding revenue is recognized. Fixed price contracts with school districts receiving funds under the federal Title I program and state-based programs are accounted for using the percentage-of-completion method. Income is recognized based on the percentage of contract completion determined by the total expenses incurred to date as a percentage of total estimated expenses at the completion of the contract. Total contract income is estimated as contract revenue less total estimated costs considering the most recent cost information. Revenues from cost-plus-fee contracts are recognized on the basis of costs incurred during the period plus the fee earned. Franchise royalties are reported as revenue as the royalties are earned and become receivable, unless collection is not reasonably assured. Revenues from educational services are recognized in the period the services are provided. Revenue from the sale of products to franchisees is recognized when shipped. Testing revenues are recognized upon the completion of tests. Revenue from language instruction and other services are recognized ratably in the period the services are rendered. Sylvan Learning Systems, Inc. and Subsidiaries Notes to Supplemental Consolidated Financial Statements 2. Accounting Policies (continued) Stock Options Granted to Employees and Non-Employees The Company records compensation expense for all stock-based compensation plans using the intrinsic value method prescribed by APB Opinion 25, Accounting for Stock Issued to Employees ("APB No. 25"). Under APB No. 25, if the exercise price of the Company's employee stock options equals the estimated fair value of the underlying stock on the date of grant, no compensation expense is generally recognized. Statement of Financial Accounting Standards No. 123, Accounting for Stock-Based Compensation ("Statement No. 123") encourages companies to recognize expense for stock-based awards based on their estimated fair value on the date of grant. Statement No. 123 requires disclosure of pro forma income and earnings per share data in the notes to the financial statements if the fair value method is not elected. The Company accounts for its stock-based compensation plans using the intrinsic value method, and supplementally discloses in Note 13 to these financial statements the pro forma information as if the fair value method has been adopted. The Company records compensation expense for all stock options granted to non-employees in an amount equal to the estimated fair value at the date of grant, determined using the Black-Scholes option valuation model. The compensation expense is recognized over the vesting period. Foreign Currency Translation The financial statements of certain foreign subsidiaries that are measured in local functional currencies have been translated into U.S. dollars using the current rate method. All balance sheet accounts have been translated using the rates of exchange at the balance sheet date. Results of operations have been translated using the average rates prevailing throughout the year. Translation gains or losses resulting from the changes in exchange rates from year to year, are accumulated as a separate component of stockholders' equity. The financial statements of other foreign subsidiaries, primarily those subsidiaries providing services overseas to Educational Testing Services, Inc. ("ETS") (see Note 19), prepare financial statements using the U.S. dollar as the functional currency. The transactions of these subsidiaries that are denominated in foreign currencies have been remeasured in U.S. dollars. Any resulting gain or loss is recorded as an adjustment of the amount due from ETS as the contract with ETS requires ETS to bear the risk of realized translation gains or losses. Sylvan Learning Systems, Inc. and Subsidiaries Notes to Supplemental Consolidated Financial Statements 2. Accounting Policies (continued) Pending Adoption of New Accounting Standards In June 1997, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 130, Reporting Comprehensive Income ("Statement No. 130"), that establishes standards for the reporting and display of comprehensive income and its components in the Company's general-purpose financial statements. Statement No. 130 only impacts display as opposed to actual amounts recorded. Other comprehensive income includes all non-owner changes in equity that are excluded from net income, such as foreign currency translation adjustments and unrealized gains and losses on the Company's available-for-sale securities. Statement No. 130 is effective for financial statements issued for fiscal years beginning after December 15, 1997. The Company will adopt this standard in its annual financial statements for 1998. In December, 1997 the Accounting Standards Executive Committee of the AICPA issued a proposed Statement of Position ("SOP"), "Reporting on the Costs of Start-Up Activities." The proposal would be effective for fiscal years beginning after December 15, 1997. The SOP as proposed would require that all costs associated with start-up activities, including one-time activities related to opening a new facility, introducing a new product or service and any organizational costs, be charged to expense as incurred. The Company will record the effect of adopting this SOP as a cumulative effect of a change in accounting principle in the year the SOP is adopted. The Company has concluded, after a preliminary review, that the adoption of the SOP will require a cumulative effect charge of between $4.0 million and $5.0 million. Reclassifications Certain amounts in the 1995 and 1996 consolidated financial statements have been reclassified to conform with the 1997 presentation. Sylvan Learning Systems, Inc. and Subsidiaries Notes to Supplemental Consolidated Financial Statements 3. Acquisitions Aspect International Language Schools, B.V. and subsidiaries On May 6, 1998 the Company consummated its acquisition of all of the outstanding stock of Aspect in exchange for 2,004,030 shares of common stock. The acquisition was accounted for as a pooling-of-interests and accordingly, the Company's consolidated financial statements for periods prior to the merger have been restated to include the combined results of operations, financial position and cash flows of Aspect (See Note 1). In May 1998, the Company expensed approximately $5.0 million of direct costs incurred by the Company and the combining shareholders, related to the merger. Aspect provides intensive English language instruction to students and professionals worldwide through its 19 language schools in five countries I-R, Inc. and Independent Child Study Teams, Inc. On May 30, 1997, the Company acquired by merger all of the outstanding stock of I-R, Inc. and Independent Child Study Teams, Inc. (collectively, "Educational Inroads") in exchange for 2,121,000 shares of common stock. I-R, Inc. and Independent Child Study Teams, Inc. were commonly owned by two shareholders. The acquisition was accounted for as a pooling of interests and accordingly, the Company's consolidated financial statements for periods prior to the merger have been restated to include the combined results of operations, financial position and cash flows of Educational Inroads. Educational Inroads provides remedial and special education services to public and non-public school systems, with current contracts in New Jersey, Maryland, Louisiana, Washington, D.C. and other school districts. Sylvan Learning Systems, Inc. and Subsidiaries Notes to Supplemental Consolidated Financial Statements 3. Acquisitions (continued) Combined and separate results of operations of Sylvan, Aspect and Educational Inroads during the years prior to the mergers are as follows:
Previously Reported by the Company Aspect Combined -------------------- ------------------ -------------------- Year ended December 31, 1997 Revenues $246,211,733 $52,459,553 $298,671,286 Net income $29,433,999 $(1,809,779) $27,624,220 Earnings per common share-diluted $.69 $0.62
Sylvan Learning Systems, Inc. and Subsidiaries Notes to Supplemental Consolidated Financial Statements 3. Acquisitions (continued)
Previously Independent Reported by the Child Study Company I-R, Inc. Teams, Inc. Aspect Combined ------------------------------------------------------------------------- Year ended December 31, 1996 Revenues $157,116,660 $ 9,825,299 $ 14,994,002 $ 35,938,380 $217,874,341 Net income $ 14,743,106 $ 31,664 $ 21,551 $ 640,632 $ 15,436,953 Earnings per common share-diluted $0.43 $0.40 Year ended December 31, 1995 Revenues $ 87,990,818 $ 9,475,103 $ 13,592,629 $ 26,658,899 $137,717,449 Net income $ 3,547,829 $ 16,882 $ 6,620 $ 241,472 $ 3,812,803 Earnings per common share- diluted $0.15 $0.14
NAI/Block Acquisition Effective December 1, 1997, the Company purchased the assets and liabilities of Block Testing Services L.P. and Block State Testing Services L.P. and also acquired all of the outstanding stock of National Assessment Institute, Inc., (collectively "NAI/Block"), commonly controlled companies engaged in the business of designing, marketing, selling, distributing and administering paper and pencil tests and the licensing of individuals. The acquisition was consummated by issuing 964,352 shares of common stock valued at $24.6 million, was accounted for using the purchase method of accounting. Sylvan Learning Systems, Inc. and Subsidiaries Notes to Supplemental Consolidated Financial Statements 3. Acquisitions (continued) The results of operations of NAI/Block for the month of December 1997 are included in the accompanying 1997 consolidated statement of income. Goodwill of $28.9 million related to the acquisition is being amortized over its estimated useful life of 25 years. Wall Street Institute International, B.V. and Affiliates Effective December 1, 1996, the Company acquired substantially all of the operating net assets of Wall Street Institute International, B.V. and its commonly controlled affiliates (collectively, "WSI"). The Company recorded the acquisition using the purchase method of accounting. WSI is a European-based franchisor and operator of learning centers that teach the English language through a combination of computer-based and live instruction. WSI has a network of franchised centers in operation throughout Europe and Latin America. The total purchase price of WSI of $21,071,000 consisted of cash of $4,921,000, 758,046 shares of restricted common stock valued at $9,250,000, 314,280 shares of unrestricted common stock valued at $5,900,000 and $1,000,000 of direct acquisition costs. The restricted stock may not be transferred by the sellers for a period of three years from the date of issuance, unless the Company, in its sole discretion, removes the restriction. Of the 758,064 shares of restricted common stock issued to the sellers, 186,438 shares are held in escrow to indemnify the Company against any subsequent losses resulting from any misrepresentation or breach of certain covenants. The unrestricted common stock held in escrow will be released in varying amounts to the sellers through 2001. Goodwill of $19.9 million is being amortized over its estimated useful life of 25 years. The cash portion of the purchase price was recorded as a current liability at December 31, 1996, and the portion of the purchase price represented by common stock was recorded as a non-current liability at December 31, 1996. Upon closing of the transaction in January 1997, the Company paid the cash portion of the purchase price to the sellers and recorded the issuance of 1,072,326 shares of common stock to the sellers as a reduction in the non-current liability (See Note 9). Sylvan Learning Systems, Inc. and Subsidiaries Notes to Supplemental Consolidated Financial Statements 3. Acquisitions (continued) The Company on the closing date of the acquisition entered into option agreements to purchase two franchisees of WSI, and granted the owners of these same franchisees put rights that require, in certain circumstances and at the election by the right holders, the Company to purchase the franchisees. At the Company's option it may purchase the two franchisees at any time during the period from September 1, 2001 through September 1, 2005 for an amount equal to seven times the previous fiscal years' earnings before interest and taxes, adjusted for certain defined items. The franchisees may require the Company to purchase substantially all of their net assets during the same four-year period if defined levels of operating results are met or exceeded at the end of the most recently completed fiscal year. The purchase price is payable 10% in cash and 90% in common stock, or at the Company's option, entirely in cash. The PACE Group Effective February 28, 1995, the Company purchased the assets and liabilities of The PACE Group ("PACE"), a provider of educational services to corporations. The initial consideration for the acquisition was 393,669 shares of common stock having an aggregate market value of $3,160,861. The acquisition was accounted for using the purchase method of accounting. Additional contingent consideration was payable in an amount equal to 6.5 times PACE's earnings before interest and income taxes (EBIT) in 1997 as elected by the sellers, determined in accordance with generally accepted accounting principles. EBIT in 1997 was $3,965,758, resulting in additional consideration of $25,777,427 payable in cash of $14,469,000 and the remainder in 344,561 shares of common stock (See Note 9). The Company has recorded this additional consideration as a liability and increased goodwill, and will amortize that amount over the remaining amortization period of 22 years. Drake Prometric, L.P. Effective September 30, 1995, the Company acquired Drake Prometric, L.P. ("Drake"), a Minneapolis based provider of computer-based certification, licensure and assessment testing programs. As of that date, Drake had a network of 820 testing centers on six continents, 472 of which were located in North America and the remainder in 69 foreign countries. Sylvan Learning Systems, Inc. and Subsidiaries Notes to Supplemental Consolidated Financial Statements 3. Acquisitions (continued) The Company acquired Drake for an initial purchase price $70.6 million, consisting of $20.0 million in cash and 8,571,429 restricted shares of common stock (the "Initial Shares"). Of the Initial Shares, 2,678,571 shares (the "Revenue Escrow Shares") were placed in escrow and will be released to the sellers to the extent that certain revenue targets relating to portions of the combined computer-based testing business are achieved from 1996 through 1998. The sellers may receive up to an additional $40.0 million (payable 12.5% in cash and the balance in either cash or restricted shares of common stock, at the Company's option) to the extent other revenue targets relating to portions of the combined computer-based testing business are achieved in 1998 or 1999 (with the measuring year selected by the sellers). The acquisition was accounted for using the purchase method of accounting. Approximately $4.8 million of contract rights and $69.8 million of goodwill were recorded. The contract rights are being amortized over their respective terms, and no term exceeds five years. Goodwill is being amortized over 25 years, its estimated useful life. The Company will record the contingent consideration consisting of the 2,678,571 Revenue Escrow Shares and the additional contingent payment of up to $40.0 million when the contingencies are resolved and the additional consideration is payable. Based on testing revenues earned by the Company in 1996 and 1997, 60% of the Revenue Escrow Shares (1,607,144 shares) have been earned through December 31, 1997. As of December 31, 1997, an additional $28.2 million of goodwill which relates to the earned shares was recorded which will be amortized over the remaining estimated useful life. The 1,071,429 Revenue Escrow Shares earned in 1997 will be released to the sellers in 1998 (See Note 9). Remedial Education and Diagnostic Services, Inc. and READS, Inc. On February 17, 1995, the Company acquired by merger all of the outstanding stock of Remedial Education and Diagnostic Services, Inc. and READS, Inc. (collectively, "READS") in exchange for 787,662 shares of common stock. The acquisition was accounted for as a pooling of interests and accordingly, the Company's financial statements for periods prior to the merger have been restated to include the results of operations, financial position and cash flows of READS. Sylvan Learning Systems, Inc. and Subsidiaries Notes to Supplemental Consolidated Financial Statements 3. Acquisitions (continued) READS is based in Philadelphia, Pennsylvania and provides remedial and education services, psychological, diagnostic and counseling services, career awareness training, and a variety of consulting services. Services are delivered under contracts with school districts, county-wide educational agencies and municipalities in the eastern United States. 4. Available-For-Sale Securities The following is a summary of available-for-sale securities (cost approximates fair value): December 31, ----------------------------- 1996 1997 ---------- ----------- Municipal securities funds $ 3,646,361 $ 8,200,000 Cash reserve fund -- 38,221,248 U.S. Treasury bills and notes 3,002,398 -- Municipal bonds 9,800,000 36,504,321 ----------- ----------- $16,448,759 $82,925,569 =========== =========== The Company has not had any significant realized or unrealized gains or losses on its investments during the periods presented. As of December 31, 1997, the Company has approximately $50.5 million of investments that mature within one year, $4.9 million of investments that mature between one and five years, $6.7 million of investments that mature between six and 20 years and $20.8 million of investments that mature beyond 20 years. These investments are classified as current as the Company views its available-for-sale securities as available for use in its current operations. Sylvan Learning Systems, Inc. and Subsidiaries Notes to Supplemental Consolidated Financial Statements 5. Acquisition of Contract Rights In 1996, the Company acquired the rights to provide computer-based tests on behalf of the National Association of Securities Dealers, Inc. ("the NASD") for a period of ten years. As part of the agreement, the Company assumed certain lease obligations and acquired the fixed assets of approximately 50 testing centers previously operated by the NASD. The Company paid the NASD $5,114,673, of which $4,871,832 related to contract rights and $242,841 related to fixed assets. In 1997, the Company incurred an additional $1,243,691 of costs related to the acquisition of contract rights from the NASD. The contract rights are being amortized over the contract life of ten years on a straight-line basis. 6. Investments Investments in Affiliates At December 31, 1997 and 1996, the Company's investments in and advances to affiliates consists primarily of its 10% voting interest in Caliber Learning Network, Inc. ("Caliber"), including related loans. Caliber is a corporate joint venture with MCI Communications Corp. formed for the purpose of providing adults throughout the United States with university-quality continuing education using multimedia technology. The Company's investment in and advances to Caliber consisted of the following at December 31: 1996 1997 ------------ ------------ Invested capital $ 1,300,000 $ 3,935,642 Loans and related interest 1,212,800 3,361,674 Amounts due for management fee 480,000 2,880,500 ------------ ------------ 2,992,800 10,177,816 Allocable share of losses from inception (141,837) (1,500,842) ------------ ------------ $ 2,850,963 $ 8,676,974 ============ ============ Sylvan Learning Systems, Inc. and Subsidiaries Notes to Supplemental Consolidated Financial Statements 6. Investments (continued) Since its inception in 1996, Caliber relied almost entirely on the Company's resources, systems, and personnel for administrative, management, accounting and financial functions. In consideration for these services, the Company charged Caliber $2,880,500, which is unpaid at December 31, 1997. This amount began to accrue interest at the prime rate plus 1% and was repaid in May 1998. Caliber has agreed to pay an annual management fee of $2.0 million in 1998 and 1999, due in equal quarterly installments. The Company has loaned to Caliber certain amounts under a line of credit that bears interest at 1% above the prime rate as published by a defined commercial bank. All amounts borrowed under the line of credit were repaid in May 1998. During 1997, the Company assigned the leases for 32 testing centers to Caliber for the use by Caliber in its operations. Upon assignment of the centers, Caliber assumed the revenue stream from the ongoing testing operations and paid the Company a fee of $4.0 million to manage the continuing testing operations. The Company also maintains investments in other affiliates totaling $3,044,639 and $3,786,755 at December 31, 1996 and 1997, respectively. The Company's allocable share of earnings (losses) related to these investments for the years ended December 31, 1996 and 1997 was $505,233 and $(772,235), respectively. Other Investments Other investments consist of non-marketable investments in common and preferred stocks of private companies in which the Company does not exercise significant influence. These investments are carried at the lower of cost or estimated net realizable value. At December 31, 1996 and 1997, other investments consist primarily of a non-voting convertible preferred stock investment in JLC Learning Corporation ("JLC"), a company that develops educational software products. The preferred stock requires the payment of cumulative dividends in the annual amount of $2 million for two years totaling $4 million, which may be paid in additional shares of preferred stock. At December 31, 1996 and 1997, the Company's investment in JLC was $21.9 million and $24.0 million, respectively. During 1996 and 1997, the Company Sylvan Learning Systems, Inc. and Subsidiaries Notes to Supplemental Consolidated Financial Statements recorded dividend income from this investment in the amount of $333,333 and $2,000,000, respectively, paid in the form of additional preferred stock. 6. Investments (continued) The Company also maintains other investments not readily marketable totaling $0.3 million and $4.0 at December 31, 1996 and 1997, respectively. 7. Bank Lines of Credit The Company has entered into a loan agreement with a bank, (hereinafter, "the credit line") that provides an unsecured revolving line of credit. The credit line allows the Company to borrow a maximum of $15.0 million through the expiration date of May 31, 1998, at which time the total outstanding principal balance can be converted into a term loan, at the option of the Company. The term loan would be repaid over 24 months from the time of issuance. The credit line and the term loan both bear interest at a floating rate equal to the 30 day London Interbank Offered Rate ("LIBOR") plus 1.15% per annum (6.96% at December 31, 1997). No amounts on the line of credit were outstanding at December 31, 1996 or December 31, 1997. 8. Long-term Debt Long-term debt consists of the following: December 31, ----------------------- 1996 1997 ---------- -------- Note payable to a bank, bearing interest at 1.10% over the LIBOR (6.63% at December 31, 1996). The loan was repaid in its entirety in 1997. $2,320,000 $ -- Other notes payable bearing interest at rates ranging from 8% to 14%. 5,272,811 3,516,024 ---------- ---------- Total long-term debt 7,592,811 3,516,024 Less: current portion of long-term debt 3,331,057 1,212,860 ---------- ---------- Classified as non-current $4,261,754 $2,303,164 ========== ========== Sylvan Learning Systems, Inc. and Subsidiaries Notes to Supplemental Consolidated Financial Statements Future maturities of long term debt are as follows: 8. Long-term Debt (continued) Year ended December 31, 1998 $1,212,860 1999 1,245,851 2000 281,651 2001 124,920 2002 96,420 thereafter 554,322 ---------- $3,516,024 ========== 9. Due to Shareholders of Acquired Companies Due to shareholders of acquired companies consists of the following (see also Note 3):
December 31, --------------------------------- 1996 1997 ------------ ------------ Amounts payable to former owners of NAI/Block, payable in 964,352 shares of common stock in January 1998 $ - $ 25,000,000 Amounts payable to former shareholders of Educational Inroads 3,232,884 - Amounts payable to former shareholders of WSI in cash 4,920,565 262,285 Amounts payable to former shareholders of WSI, payable in 1,072,326 shares of common stock in January 1997 15,150,115 - Amounts payable to former shareholders of PACE in cash - 13,531,910 Amounts payable to former shareholders of PACE, payable in common stock in April 1998 - 11,308,427 Amounts payable to former shareholders of Drake in common stock (1996 - 535,715 shares; 1997 - 1,071,429 shares) 8,142,856 20,057,151 ------------ ------------ 31,446,420 70,159,773 Less: current portion (4,920,565) (13,794,195) ------------ ------------ $ 26,525,855 $ 56,365,578 ============ ============
Sylvan Learning Systems, Inc. and Subsidiaries Notes to Supplemental Consolidated Financial Statements 10. Leases The Company conducts its operations principally from leased facilities. These facilities include the Company's corporate headquarters and other office locations, warehouse space, certain testing sites, and Company-owned learning centers. The terms of these leases are five years or less, with the exception of the Company's corporate headquarters, which has a lease term of ten years, and generally contain renewal options. The Company also leases certain equipment under operating leases of 36 months or less. Future minimum lease payments at December 31, 1997, by year and in the aggregate, under all non-cancelable operating leases are as follows: Years ending December 31: 1998 $ 8,309,081 1999 7,241,315 2000 6,350,558 2001 5,346,719 2002 5,165,184 Thereafter 16,401,472 ----------- $48,814,329 =========== Rent expense for cancelable and non-cancelable leases was $4.5 million, $7.5 million and $9.5 million for the years ended December 31, 1995, 1996 and 1997, respectively. 11. Contingencies On November 18, 1996, ACT, Inc. filed suit against the Company alleging that the Company violated federal antitrust laws and committed various state law torts in connection with the operations of its computer-based testing operations and in obtaining a testing services contract from the NASD. The Company believes the grounds of the lawsuit are without merit and intends to defend the lawsuit vigorously. Management is unable to predict the ultimate outcome of the lawsuit, but believes that the ultimate resolution of the matter will not have a material effect on consolidated financial position. The Company is subject to other legal actions arising in the ordinary course of its business. In management's opinion, the Company has adequate legal defenses and/or insurance coverage with Sylvan Learning Systems, Inc. and Subsidiaries Notes to Supplemental Consolidated Financial Statements respect to the eventuality of such actions and does not believe any settlement would materially affect the Company's financial position. 12. Fair Value of Financial Instruments The fair value of the Company's financial instruments, which consist primarily of cash and cash equivalents, accounts and notes receivable, available-for-sale investments, accounts payable, due to shareholders of acquired companies (cash portion), and short and long-term debt, approximate their carrying amounts reported in the consolidated balance sheets. It was not practical to estimate the fair value of the Company's other investments because of the lack of quoted market prices of the underlying equity securities and the inability to determine fair value without incurring excessive costs. Management does not believe that the value of these investments have been impaired. 13. Stock Options and Warrants Stock Options The Company has an Employee Stock Option Plan ("the Employee Plan") which provides for the granting of stock options to purchase up to 5,700,000 shares of common stock. All options granted under the Employee Plan vest ratably over a five-year period and expire six years after date of grant. At December 31, 1997, options to purchase 5,629,799 shares of common stock have been granted under the Employee Plan. Under a Management Stock Option Plan ("Management Plan"), the Company has outstanding stock options at December 31, 1997 to purchase 241,275 shares of common stock for $7.50 per share. All outstanding options are fully vested, and expire on December 1, 2001. No additional options may be granted under the Management Plan. In March 1996, the Company established the Senior Management Stock Option Plan ("the Senior Management Plan") to replace the Management Plan. The Senior Management Plan provides for the granting of stock options to purchase up to 3,375,000 shares of common stock. At December 31, 1997, options to purchase 1,552,500 shares of common stock have been granted under the Senior Management Plan. Options granted under this plan expire ten years after the date of grant. Of this amount, options for 247,500 shares became immediately vested, with the balance vesting ratably over three years. Sylvan Learning Systems, Inc. and Subsidiaries Notes to Supplemental Consolidated Financial Statements 13. Stock Options and Warrants (continued) In October 1993 the stockholders approved the establishment of the Director Stock Option Plan ("Director Plan") for all non-employee members of the Board of Directors. Under the Director Plan, options to purchase 258,750 shares of common stock may be issued to certain members of the Board of Directors. No individual is eligible to receive more than 50,625 options under this plan and options granted under this plan expire at varying times three months after a director ceases his term on the Board. At December 31, 1997, options to purchase 253,125 shares of common stock have been granted under the Director Plan. During 1997, the Company established the Sylvan Technology Center Stock Option Plan ("the STC Plan") for the franchisee owners of Sylvan Technology Centers. The STC Plan provides for the granting of stock options to purchase up to 450,000 shares of common stock. During 1997, 316,500 options were granted that vest ratably over a three-year period and expire 10 years after the date of grant or on the date of cessation of operations of the center. The fair value of these options, determined using the Black-Scholes option valuation model, was $1,386,000, of which $550,000 of expense was recognized in 1997, with the remainder to be recognized in expense over the next three years as the options vest. The following table summarizes the stock option activity of the Company.
1995 1996 1997 -------------------------------------------------------------------------------- Weighted Weighted Average Average Exercise Exercise Options Options Price Options Price -------------------------------------------------------------------------------- Outstanding - beginning of year 3,862,097 4,852,727 $ 5.13 6,921,020 $ 8.71 Granted 1,378,625 2,771,813 14.61 1,713,603 23.73 Exercised (387,995) (576,845) 7.25 (1,620,813) 2.92 Forfeited - (126,675) 7.47 (78,723) 11.83 -------------------------------------------------------------------------------- Outstanding - end of year 4,852,727 6,921,020 $ 8.71 6,935,087 $13.75 ================================================================================ Exercisable at end of year 2,243,253 2,688,468 $ 4.45 2,691,177 $ 8.51 ================================================================================
Sylvan Learning Systems, Inc. and Subsidiaries Notes to Supplemental Consolidated Financial Statements
1995 1996 1997 -------------------------------------------------------------------------------- Weighted Weighted Average Average Exercise Exercise Options Options Price Options Price -------------------------------------------------------------------------------- Weighted-average fair value of options granted during the year $ 5.55 $ 7.15 ========== ==========
13. Stock Options and Warrants (continued) Exercise prices for options outstanding as of December 31, 1997 ranged from $3.48 to $29.25 as follows:
--------------------------------------------------------------------------------------------------------------- Weighted Average Weighted Weighted Average Remaining Average Range of Exercise Prices of Contractual Life Exercise Prices Exercise Options Options of Options Options of Options Prices Outstanding Outstanding Outstanding Exercisable Exercisable --------------------------------------------------------------------------------------------------------------- $3.48-$6.08 1,549,125 $ 4.31 2.0 1,216,643 $ 4.27 --------------------------------------------------------------------------------------------------------------- $6.78-$11.33 966,051 8.75 3.7 553,353 8.37 --------------------------------------------------------------------------------------------------------------- $13.55-$19.77 3,237,910 15.36 6.7 921,181 14.20 --------------------------------------------------------------------------------------------------------------- $22.35-$29.25 1,182,000 25.63 5.8 -- -- ---------------------------------------------------------------------------------------------------------------
For the years ended December 31, 1996 and 1997, pro forma net income and earnings per share information required by Statement 123 has been determined as if the Company had accounted for its stock options using the fair value method. The fair value of these options was estimated at the date of grant using a Black-Scholes option pricing model with the following weighted average assumptions for 1996 and 1997: risk-free interest rate of 6.00%, dividend yield of 0%, volatility factors of the expected market price of the Company's common stock of .399 and .280, respectively, and an expected life of granted options which varies from zero to five years depending upon the vesting period. The Black-Scholes option valuation model was developed for use in estimating the fair value of traded options which have no vesting restrictions and are fully transferable. In addition, option valuation models require the input of highly subjective assumptions including the expected stock price volatility. Because the Company's stock options have characteristics significantly different from those of traded options and because changes in the subjective input assumptions can materially affect the fair value estimate, in management's opinion, the existing models do not necessarily provide a reliable single measure of the fair value of its stock options. Sylvan Learning Systems, Inc. and Subsidiaries Notes to Supplemental Consolidated Financial Statements 13. Stock Options and Warrants (continued) For purposes of pro forma disclosures, the estimated fair value of the options is amortized to expense over the options' vesting periods. The Company's pro forma information follows: - -------------------------------------------------------------------------------- 1995 1996 1997 - -------------------------------------------------------------------------------- Pro forma net income $2,916,233 $12,579,181 $24,197,094 - -------------------------------------------------------------------------------- Pro forma earnings per share: - -------------------------------------------------------------------------------- Basic $0.12 $0.34 $0.57 - -------------------------------------------------------------------------------- Diluted $0.11 $0.33 $0.55 - -------------------------------------------------------------------------------- The effect of compensation expense from stock options on 1995 pro forma net income reflects only the vesting of 1995 awards. However, 1996 and 1997 pro forma net income reflects additional years of vesting of the prior year awards and the first year of vesting of current year awards. Because the granted stock options vest over periods ranging from zero to five years, not until 2001 is the full effect of recognizing compensation expense for stock options representative of the possible effects on pro forma net income for future years. Stock Warrants In July 1993 warrants to purchase 359,046 of common stock for $3.48 per share were issued in connection with a $5.0 million financing. Warrants to purchase 205,092, 81,686 and 7,185 shares of common stock were exercised in 1995, 1996 and 1997, respectively. The remaining 57,902 warrants expire in July 1998. 14. Impairment Loss In September 1995, the Company determined that certain assets of Sylvan Prometric were impaired as a result of the acquisition of Drake. These assets, consisting of computer equipment, software and other assets, were impaired because of dissimilar technical requirements for Drake Sylvan Learning Systems, Inc. and Subsidiaries Notes to Supplemental Consolidated Financial Statements computer-based tests, or because their use was limited by virtue of the acquisition of similar productive assets from Drake. The amount of the impairment loss was determined by evaluating the likely sales proceeds from the disposition of the assets as compared to their book value. 14. Impairment Loss (continued) In May 1997, the Company determined that certain assets of Sylvan Prometric were impaired as a result of certain strategic changes that were made as a result of pursuing the National Education Corporation ("NEC") acquisition (see Note 15). During and after the acquisition negotiations with NEC, the Company developed certain plans that resulted in required changes in both software systems and hardware currently utilized in Sylvan Prometric's network of centers. The plans continued to be valid for the Company even after the NEC acquisition was terminated. The impaired assets, consisting of computer equipment and software, were impaired as a result of changes in the technical requirements and specifications of certain computer hardware and software. The amount of the impairment loss was determined by evaluating the likely sales proceeds from the disposition of the assets compared to their book value. The Company determined that it was unlikely that the net cash proceeds from the sale of any assets would be significant, and therefore recorded an impairment loss equal to the net book value of the assets of $4.0 million. 15. Termination Fee In March 1997, the Company and NEC executed a definitive agreement pursuant to which the Company was to acquire NEC. In May 1997, NEC accepted the offer of Harcourt General, Inc. to acquire all of the stock of NEC which resulted in the termination of NEC's agreement with the Company and NEC's payment to the Company of the $30.0 million termination fee required by that agreement. The Company also incurred $1.5 million of expenses in connection with the NEC transaction, and reported the net termination fee of $28.5 million in 1997. 16. Contributions During 1997, the Company made certain cash expenditures and common stock contributions resulting in an aggregate expense to the Company of approximately $21.5 million. The $21.5 million, recorded as operating expenses, was attributable to contributions of (i) $3.0 million in cash Sylvan Learning Systems, Inc. and Subsidiaries Notes to Supplemental Consolidated Financial Statements and common stock valued at $7.0 million to IT Training Marketing Company, a nonprofit corporation whose sole purpose is to fund promotional and channel support programs for the Sylvan Prometric distribution channel, (ii) common stock valued at $5.0 million to SLC National Advertising Fund, Inc., a nonprofit corporation whose sole purpose is to develop and fund advertising programs for the Sylvan Learning Centers and (iii) common stock valued at $6.5 million to Sylvan Learning Foundation, a nonprofit foundation formed to promote various educational pursuits. 17. Income Taxes Significant components of the provision for income taxes are as follows: Year ended December 31, ------------------------------------------- 1995 1996 1997 -------- ---------- ----------- Current: Federal $257,155 $5,074,508 $ 8,962,538 Foreign 268,278 549,755 1,291,588 State 217,751 1,402,547 1,617,891 -------- ---------- ----------- Total current 743,184 7,026,810 11,872,017 Deferred (benefit): Federal (300,168) 1,773,051 3,395,715 Foreign - - 306,446 State (87,145) 334,863 851,611 -------- ---------- ----------- Total deferred (387,313) 2,107,914 4,553,772 -------- ---------- ----------- Total provision $355,871 $9,134,724 $16,425,789 ======== ========== =========== For the years ended December 31, 1996 and 1997, foreign income before income taxes was approximately $3.8 million and $12.9 million, respectively. The Company uses the liability method to account for income taxes. Deferred income taxes reflect the net tax effects of temporary differences between the carrying amount of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. Sylvan Learning Systems, Inc. and Subsidiaries Notes to Supplemental Consolidated Financial Statements 17. Income Taxes (continued) Significant components of the Company's deferred tax assets and liabilities are as follow: Year ended December 31, ----------------------------- 1996 1997 ------------ ------------ Deferred tax assets: Net operating loss carryforwards $ 2,277,600 $ 765,153 Loss on impairment of assets 71,601 779,429 Deferred revenue 443,618 629,659 Allowance for doubtful accounts 301,205 548,046 Advertising costs -- 5,304,604 Amortization of intangible assets 459,040 642,977 Equity share of losses from affiliates 53,841 827,089 Charitable contribution carryforward 23,746 2,424,881 Tax credit carryforwards 76,544 925,844 Other 168,780 538,509 ------------ ------------ Total deferred tax assets 3,875,975 13,386,191 Deferred tax liabilities: Deferred contract costs 1,746,807 2,066,448 Contract rights 316,619 169,586 Depreciation 996,869 1,755,270 Deferred income -- 11,388,000 Accrued receivables 266,432 558,646 Other 302,610 564,818 ------------ ------------ Total deferred tax liabilities 3,629,337 16,502,768 ------------ ------------ Net future income tax benefit (liability) 246,638 (3,116,577) Valuation allowance for net deferred tax assets (2,277,600) (765,153) ------------ ------------ Net deferred tax liabilities $ (2,030,962) $ (3,881,730) ============ ============ Sylvan Learning System, Inc. and Subsidiaries Notes to Supplemental Consolidated Financial Statements 17. Income Taxes (continued) The net operating loss carryforwards at December 31, 1997 are related to a subsidiary of the Company, and are available only to offset future taxable income of the subsidiary. These net operating loss carryforwards will begin to expire in 2007. The reconciliation of the reported income tax expense to the amount that would result by applying the U.S. federal statutory tax rates to income before income taxes is as follows:
Year ended December 31, -------------------------------------------- 1995 1996 1997 ------------ ------------ ------------ Tax expense at U.S. statutory rate $ 1,417,000 $ 8,354,000 $ 14,977,000 Permanent differences 828,000 813,000 2,662,000 State income tax expense, net of federal tax effect 138,000 1,130,000 1,555,000 Tax effect of foreign income taxed at lower rate (87,000) (734,000) (3,244,000) Change in valuation allowance affecting tax expense (2,026,000) -- -- Utilized tax credits -- (254,000) -- Other 85,871 (174,276) 475,789 ------------ ------------ ------------ $ 355,871 $ 9,134,724 $ 16,425,789 ============ ============ ============
Sylvan Learning System, Inc. and Subsidiaries Notes to Supplemental Consolidated Financial Statements 18. Earnings Per Share In 1997, the Financial Accounting Standards Board issued Statement No. 128, Earnings Per Share ("Statement No. 128"). Statement No. 128 replaced the calculation of primary and fully diluted earnings per share with basic and diluted earnings per share. Unlike primary earnings per share, basic earnings per share excludes any dilutive effects of options, warrants and convertible securities. Diluted earnings per share is very similar to the previously reported fully-diluted earnings per share. Earnings per share amounts for all periods have been presented, and where appropriate, restated, to conform to the Statement No. 128 requirements. The following table summarizes the computations of basic and diluted earnings per share:
Year ended December 31, ------------------------------------------------- 1995 1996 1997 ------------ ------------ ------------- Numerator used in basic and diluted earnings per common share: Net income $ 3,812,803 $ 15,436,953 $ 27,624,220 ============ ============ ============= Denominator: Denominator for basic earnings per common share - weighted average shares 24,702,041 36,547,254 42,332,820 Effect of dilutive securities: Employee stock options 2,776,655 2,069,228 1,849,884 Common stock contingently issuable 143,540 267,264 628,317 --------- --------- ---------- Total dilutive potential common shares 2,920,194 2,336,492 2,478,201 --------- --------- ---------
Sylvan Learning System, Inc. and Subsidiaries Notes to Supplemental Consolidated Financial Statements
Year ended December 31, ------------------------------------------------- 1995 1996 1997 ------------ ------------ ------------- Denominator for diluted earnings per common share - weighted average shares and assumed conversions 27,622,236 38,883,746 44,811,021 ========== ========== ========== Earnings per common share, basic $0.15 $0.42 $0.65 Earnings per common share, diluted $0.14 $0.40 $0.62
18. Earnings Per Share (continued) The Company as of December 31, 1997 has reserved 9,028,769 shares of common stock for future issuance upon the exercise of all outstanding stock purchase warrants, the exercise of all outstanding stock options and the issuance of shares of common stock in connection with purchase business combinations. 19. Major Customers and Concentration of Credit Risk In 1997, the Company extended its agreement with Educational Testing Services ("ETS") to be the exclusive commercial provider of ETS domestic computer-based tests through the year 2006. The contract to provide international computer-based tests runs through the year 2004. The international testing contract with ETS stipulates that the Company will be compensated for its services for a fee equal to approved costs plus 10 percent, and the company recognizes revenues accordingly. Operating costs under the contract will be paid at cost plus 10 percent on a monthly basis by ETS. Start-up costs will be paid ratably over a period not to exceed 10 years. Total revenues from ETS represented approximately 13.1%, 9.0% and 14.4% of consolidated revenues for the years ended December 31, 1995, 1996 and 1997, respectively. The testing business acquired from Drake in September 1995 is highly concentrated with two customers. These customers contributed approximately 20.1% and 13.2% to consolidated revenues for the years ended December 31, 1996 and 1997, respectively. The Company expects the contracts with these two customers to be renewed at the expiration date of the current contracts. The failure of these contracts to be renewed under similar terms would have a detrimental effect on future operating results and significantly impair the Company's ability to recover the remaining goodwill balance of approximately $91.6 million related to the acquisition of Drake. Financial instruments which potentially subject the Company to credit risk are investments in available-for-sale securities, accounts receivable and notes receivable. The Company maintains an allowance for losses on receivables based on the collectibility of all amounts owed. The Company Sylvan Learning System, Inc. and Subsidiaries Notes to Supplemental Consolidated Financial Statements generally does not require collateral for trade receivables. Notes receivable are generally collateralized by assets of the debtors. At December 31, 1997, the Company does not have any significant concentrations of credit risk. 20. Defined Contribution Retirement Plan The Company sponsors a defined contribution retirement plan under section 401(k) of the Internal Revenue Code. The provisions of this plan allow for voluntary employee contributions, subject to certain annual limitations, and discretionary Company contributions which are allocated to eligible participants based upon compensation. All employees are eligible after meeting certain service requirements. The Company made a discretionary contribution to this plan in 1997 of $248,000. 21. Business and Geographic Segment Information In June 1997, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 131, Disclosures about Segments of an Enterprise and Related Information ("Statement 131"). Statement 131 supersedes Financial Accounting Standards Board Statement No. 14, Financial Reporting for Segments of a Business Enterprise ("Statement 14"), and establishes new standards for the way that public enterprises report selected information about operating segments in annual and interim financial statements. It also established standards for related disclosures about products and services, geographical areas, and major customers. Statement 131 is effective for financial statements issued for fiscal years beginning after December 15, 1997. The Company has elected to adopt this statement in 1997, and accordingly, the disclosures for all periods have been presented, and where appropriate, restated to conform to the Statement 131 requirements. Sylvan Learning System, Inc. and Subsidiaries Notes to Supplemental Consolidated Financial Statements 21. Business and Geographic Segment Information (continued) Description of Services From Which Each Reportable Segment Derives its Revenues The Company provides lifelong educational services through three distinct operating segments. The Sylvan Learning Centers division provides personalized instructional services to students of all ages and skill levels, through its network of franchised and Company-owned learning centers located in 49 states, five Canadian provinces, Hong Kong, Guam and South Korea. The Sylvan Contract Educational Services division provides educational services and professional development to children and adults through contracts with school systems and other organizations. These services to children are delivered at over 500 schools and in the case of its professional development services for adults, at the contracting parties' facilities. The Sylvan Prometric division delivers computer-based testing for academic admissions and professional certification programs through a network of computer testing centers located throughout the world, and includes the operations of Wall Street Institute, a European-based franchisor and operator of learning centers for English language instruction that will administer certain computer-based testing programs throughout Europe and Latin America and Aspect, an international provider of intensive English language instruction to professionals worldwide through its 16 language schools in five countries. Measurement of Segment Profit or Loss and Segment Assets The Company evaluates performance and allocates resources based on operating income before corporate general and administrative expenses and income taxes. The accounting policies used by the reportable segments are the same as those used by the Company as described in Note 2 to the consolidated financial statements. There are no significant intercompany sales or transfers. Factors Management Uses to Identify the Company's Reportable Segments Sylvan Learning System, Inc. and Subsidiaries Notes to Supplemental Consolidated Financial Statements The Company's reportable segments are business units that offer distinct services. The segments are managed separately as they have different customer bases and delivery channels. 21. Business and Geographic Segment Information (continued) Factors Management Uses to Identify the Company's Reportable Segments (continued) The following table sets forth information on the Company's reportable segments:
Year Ended December 31, 1995 ---------------------------- Contract Learning Centers Educational Services Sylvan Prometric ---------------- -------------------- ---------------- Revenues $26,063,191 $50,429,662 $61,224,596 Depreciation and amortization 895,430 1,584,352 5,924,570 Loss on impairment of assets - - 3,315,541 Segment profit 7,387,957 2,745,082 1,462,820 Segment assets 12,863,792 26,568,393 111,874,499 Year Ended December 31, 1996 ---------------------------- Contract Learning Centers Educational Services Sylvan Prometric ---------------- -------------------- ---------------- Revenues $36,799,287 $58,185,985 $122,889,069 Depreciation and amortization 945,968 1,939,778 10,351,287 Segment profit 11,242,406 4,812,800 16,463,361 Segment assets 13,967,337 27,495,706 171,682,695 Year Ended December 31, 1997 ---------------------------- Contract Learning Centers Educational Services Sylvan Prometric ---------------- -------------------- ---------------- Revenues $44,289,019 $66,582,280 $187,799,987 Depreciation and amortization 672,831 1,613,686 14,673,904 Loss on impairment of assets - - 4,000,000
Sylvan Learning System, Inc. and Subsidiaries Notes to Supplemental Consolidated Financial Statements
Year Ended December 31, 1997 ---------------------------- Contract Learning Centers Educational Services Sylvan Prometric ---------------- -------------------- ---------------- Unusual item - contribution to marketing fund - - 10,000,000 Significant non-cash charges (advertising) 5,000,000 - - Segment profit 7,580,159 10,525,659 17,482,619 Segment assets 21,843,781 57,064,257 275,522,399
21. Business and Geographic Segment Information (continued) Factors Management Uses to Identify the Company's Reportable Segments (continued) The following tables reconcile the reported information on segment profit and assets to income before income taxes and total assets reported in the statements of income and balance sheets, respectively for the years ended December 31, 1995, 1996 and 1997:
1995 1996 1997 ---- ---- ---- Operating Profit: Total profit for reportable segments $ 11,595,859 $ 32,518,567 $ 35,588,437 Corporate general and administrative expense (6,205,480) (8,755,406) (22,075,863) Other income (expense), net of direct costs (1,221,705) 808,516 30,537,435 ------------- ------------- ------------- Income before income taxes $ 4,168,674 $ 24,571,677 $ 44,050,009 ============= ============= ============= Assets: Segment assets $ 151,306,684 $ 213,145,738 $ 354,430,437 Cash and available for sale securities - Corporate 33,637,176 27,381,251 86,630,693 Deferred tax asset 1,271,925 619,553 3,737,831 Property, plant and equipment - Corporate 1,007,488 5,249,080 6,809,758
Sylvan Learning System, Inc. and Subsidiaries Notes to Supplemental Consolidated Financial Statements
1995 1996 1997 ---- ---- ---- Investments in and advances to affiliates 182,320 5,895,602 12,463,729 Other investments 338,681 22,219,888 28,017,457 Other non-segment assets -- 3,103,209 4,223,179 ------------- ------------- ------------- Total assets $ 187,744,274 $ 277,614,321 $ 496,313,084 ============= ============= =============
21. Business and Geographic Segment Information (continued) Factors Management Uses to Identify the Company's Reportable Segments (continued) Included in corporate general and administrative expense for the year ended December 31, 1997 was a contribution of the Company's common stock valued at $6.5 million as discussed in Note 16 to these financial statements. Depreciation expense in the amounts of .7 million, $1.1 million and $2.3 million were charged to corporate departments during the years ended December 31, 1995, 1996 and 1997, respectively. Enterprise-Wide Disclosures - Information on Geographic Areas
Year Ended December 31, 1995 ---------------------------- Revenues Long-lived Assets -------- ----------------- United States $109,101,746 $99,401,709 Foreign countries - total 28,615,703 10,023,796 ---------- --------------- Consolidated total $137,717,449 $109,425,505 ============ ============ Year Ended December 31, 1996 ---------------------------- Revenues Long-lived Assets -------- ----------------- United States $163,440,192 $128,537,140 Foreign countries - total 54,434,149 29,002,643 ---------- ----------
Sylvan Learning System, Inc. and Subsidiaries Notes to Supplemental Consolidated Financial Statements
Year Ended December 31, 1996 ---------------------------- Revenues Long-lived Assets -------- ----------------- Consolidated total $217,874,341 $157,539,783 ============ ============
21. Business and Geographic Segment Information (continued) Enterprise-Wide Disclosures - Information on Geographic Areas (continued)
Year Ended December 31, 1997 ---------------------------- Revenues Long-lived Assets -------- ----------------- United States $209,996,157 $215,136,765 Foreign countries - total 88,675,129 35,800,057 ------------ ------------ Consolidated total $298,671,286 $250,936,822 ============ ============
Revenues from individual foreign countries did not exceed 10% of consolidated revenues in any of the years presented. Long-lived assets domiciled in individual foreign countries did not exceed 10% of consolidated long-lived assets in any of the years presented. Note 19 to the financial statements contains information about major customers of the Company. 22. Supplemental Cash Flow Information Interest payments were $2.6 million, $1.3 million and $0.8 million for the years ended December 31, 1995, 1996 and 1997, respectively. The 1995 amount includes imputed interest payments of $1.1 million related to the acquisition of Drake. Income tax payments were $1.9 million, $4.2 million and $2.7 million for the years ended December 31, 1995, 1996, and 1997, respectively. Sylvan Learning System, Inc. and Subsidiaries Notes to Supplemental Consolidated Financial Statements 23. Quarterly Financial Data (Unaudited)
Quarter ended ------------------------------------------------- March 31, June 30, September 30, December 31, 1997 1997 1997 1997 ---- ---- ---- ---- (Amounts in thousands, except per share data) Operating revenues $ 60,821 $ 68,925 $ 71,375 $ 97,550 Operating expenses 56,547 83,296 60,788 80,527 Loss on impairment of assets -- 4,000 -- -- -------- -------- -------- -------- Operating income (loss) 4,274 (18,371) 10,587 17,023 Non-operating items, net 335 28,935 807 460 -------- -------- -------- -------- Income before income taxes 4,609 10,564 11,394 17,483 Income taxes (1,955) (3,917) (3,995) (6,559) -------- -------- -------- -------- Net income $ 2,654 $ 6,647 $ 7,399 $ 10,924 ======== ======== ======== ======== Net income per common share: Basic $ 0.07 $ 0.17 $ 0.17 $ 0.24 ======== ======== ======== ======== Diluted $ 0.06 $ 0.16 $ 0.16 $ 0.22 ======== ======== ======== ======== Weighted average shares outstanding: Basic 40,073 40,253 43,623 45,438 ======== ======== ======== ======== Diluted 42,881 42,668 45,887 49,022 ======== ======== ======== ========
Sylvan Learning System, Inc. and Subsidiaries Notes to Supplemental Consolidated Financial Statements During the second quarter of 1997, the Company recognized an impairment loss of $4.0 million, income from a termination fee of $28.5 million and recorded expense related to contributions which totaled $21.5 million. These transactions are described in Notes 14, 15 and 16, respectively. The net effect of the above non-recurring items was an increase in pre-tax income of $3.0 million and net income of $1.9 million, or $0.04 per diluted share. 23. Quarterly Financial Data (Unaudited) (continued) Diluted earnings per common share for the year ended December 31, 1997 is $0.62. The total diluted earnings per common share derived from the addition of the quarterly amounts in 1997 is $0.60. This difference is caused by differences in the estimated effect of contingently issuable shares related to the acquisition of PACE in the quarterly periods as compared to the annual period. 24. Subsequent Event In May 1998, the Company increased the number of authorized shares of common stock from 40,000,000 shares to 90,000,000 shares and declared a 3-for-2 stock split of its common stock for stockholders of record on April 8, 1998. Accordingly, all share and per share data including stock option, warrant and earnings per share information has been restated in the supplemental consolidated financial statements to retroactively reflect the stock split. EX-99.3 13 EXHIBIT 99.3 Exhibit 99.3 Supplemental Consolidated Financial Statements For the Three Months Ended March 31, 1997 and March 31, 1998 (Unaudited) INDEX -----
Page No. -------- Supplemental Consolidated Financial Statements (Unaudited) Supplemental Consolidated Balance Sheets - December 31, 1997 and March 31, 1998............................................ 2 Supplemental Consolidated Statements of Income - Three months ended March 31, 1997, three months ended March 31, 1998............ 4 Supplemental Consolidated Statements of Cash Flows - Three months ended March 31, 1997, three months ended March 31, 1998............ 5 Notes to Unaudited Supplemental Consolidated Financial Statements - March 31, 1998..................................................... 6
1 Sylvan Learning Systems, Inc. and Subsidiaries Supplemental Consolidated Balance Sheets ($ and shares in thousands)
December 31, March 31, 1997 1998 ----------------- ----------------- (Restated-Note A) (Restated-Note A) (Unaudited) Assets Current assets: Cash and cash equivalents $ 29,650 $ 26,517 Available-for-sale securities 82,926 57,880 Receivables: Accounts receivable 60,679 58,360 Costs and estimated earnings in excess of billings on uncompleted contracts 3,900 6,463 Notes receivable 2,943 3,201 Other receivables 8,752 1,076 ------------ ------------- 76,274 69,100 Allowance for doubtful accounts (2,508) (2,724) ------------ ------------- 73,766 66,376 Inventory 4,999 7,009 Deferred income taxes 3,738 3,719 Prepaid expenses and other current assets 6,550 7,499 ------------ ------------- Total current assets 201,629 169,000 Notes receivable, less current portion 6,232 6,176 Costs and estimated earnings in excess of billings on uncompleted contracts, less current portion 352 161 Property and equipment: Land and buildings 5,710 8,238 Furniture and equipment 58,709 70,717 Leasehold improvements 7,985 8,567 ------------ ------------- 72,404 87,522 Accumulated depreciation (21,160) (23,657) ------------ ------------- 51,244 63,865 Intangible assets: Goodwill 183,004 206,586 Contract rights 13,973 13,973 Other 2,522 2,777 ------------ ------------- 199,499 223,336 Accumulated amortization (16,714) (19,055) ------------ ------------- 182,785 204,281 Deferred contract costs, net of accumulated amortization of $6,205 as of December 31, 1997 and $7,500 as of March 31, 1998 10,324 11,767 Investments in and advances to affiliates 12,464 16,024 Other investments 28,017 28,524 Other assets 3,266 4,490 ------------ ------------- Total assets $ 496,313 $ 504,288 ============ =============
2 Sylvan Learning Systems, Inc. and Subsidiaries Supplemental Consolidated Balance Sheets ($ and shares in thousands)
December 31, March 31, 1997 1998 ------------------- ----------------- (Restated-Note A) (Restated-Note A) (Unaudited) Liabilities and stockholders' equity Current liabilities: Accounts payable and accrued expenses $ 40,707 $ 42,404 Income taxes payable 5,590 4,734 Current portion of long-term debt 1,213 1,608 Current portion of due to shareholders of acquired companies 13,794 13,870 Deferred revenue 26,289 24,276 Other current liabilities 1,281 1,405 ------------ ----------- Total current liabilities 88,874 88,297 Long-term debt, less current portion 2,303 3,481 Deferred income taxes 7,620 7,612 Due to shareholders of acquired companies, less current portion 56,366 31,365 Other long-term liabilities 902 369 Commitments and contingent liabilities - - ------------ ----------- Total liabilities 156,065 131,124 ------------ ----------- Stockholders' equity: Preferred stock, par value $.01 per share--authorized 10,000 shares, no shares issued and outstanding as of December 31, 1997 and 1996 - - Common stock, par value $.01 per share--authorized 90,000 shares, issued and outstanding shares of 45,450 as of December 31, 1996 and 46,642 as of March 31, 1998 455 466 Additional paid-in capital 301,897 330,020 Retained earnings 39,057 43,603 Foreign currency translation adjustments (1,161) (925) ------------ ----------- Total stockholders' equity 340,248 373,164 ------------ ----------- Total liabilities and stockholders' equity $ 496,313 $ 504,288 ============ ===========
See accompanying notes. 3 Sylvan Learning Systems, Inc. and Subsidiaries Supplemental Consolidated Statements of Income (Unaudited) ($ in thousands, except per share amounts)
Three months ended March 31, ---------------------------------------- 1997 1998 ---------------------------------------- (Restated-Note A) (Restated-Note A) Revenues $ 60,821 $ 86,323 Cost and expenses Direct costs 53,586 76,781 General and administrative expense 2,961 3,327 ------------ ----------- Total expenses 56,547 80,108 ------------ ----------- Operating income 4,274 6,215 Other income (expense) Investment and other income 763 1,713 Interest expense (318) (169) Equity in net loss of affiliates (110) (1,177) ------------ ----------- Income before income taxes 4,609 6,582 Income taxes (1,955) (2,315) ------------ ----------- Net income $ 2,654 $ 4,267 ============ =========== Earnings per common share, basic $0.07 $0.09 ============ =========== Earnings per common share, diluted $0.06 $0.09 ============ ===========
See accompanying notes. 4 Sylvan Learning Systems, Inc. and Subsidiaries Supplemental Consolidated Statements of Cash Flows (Unaudited) ($ in thousands)
Three Months Ended March 31, ---------------------------------------- 1997 1998 ---------------------------------------- Operating activities Net income $ 2,654 $ 4,267 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation 1,986 2,972 Amortization 2,109 3,399 Non-cash dividend income (500) (500) Provision for doubtful accounts 47 176 Equity in net loss of affiliates 110 1,177 Deferred taxes (7) (7) Changes in operating assets and liabilities: Accounts and notes receivable (4,292) 9,545 Cost and estimated earnings in excess of billings on uncompleted contracts 953 (2,372) Inventory 20 (730) Prepaid expenses and other current assets 658 (840) Other assets (902) (1,224) Accounts and notes payable and accrued expenses (5,620) 486 Billings in excess of costs and estimated earnings on uncompleted contracts 553 392 Other current liabilities (87) 207 Deferred revenue and other long-term liabilities 2,847 (3,321) ---------- ----------- Net cash provided by operating activities 529 13,627 ---------- ----------- Investing activities Purchase of available-for-sale securities (4,827) (4,354) Proceeds from sale of available-for-sale securities 11,045 29,400 Investment in and advances to affiliates (2,416) (4,086) Increase in other investments (742) - Purchase of property and equipment (3,373) (14,587) Proceeds from sale of property and equipment 43 - Cash paid for Canter, net of cash received - (24,262) Cash paid for other acquired businesses, net of cash received - (24) Increase in other intangible assets - (255) Expenditures for deferred contract costs and other assets (11) (193) ---------- ----------- Net cash used in investing activities (281) (18,361) ---------- ----------- Financing activities Payments on loans from stockholders of acquired companies (4,671) (15) Proceeds from exercise of options and warrants 922 1,403 Distributions to (repayments from) shareholders of pooled entity (550) 238 Payments on long-term debt and capital lease obligations (2,932) (789) Proceeds from issuance of long-term debt 56 1,117 Payments on bank lines of credit - (544) Proceeds from bank lines of credit 7,164 - ---------- ----------- Net cash provided by (used in) financing activities (11) 1,410 ---------- ----------- Effects of exchange rate changes on cash (394) 191 ---------- ----------- Net decrease in cash and cash equivalents (157) (3,133) Cash and cash equivalents at beginning of period 18,564 29,650 ---------- ----------- Cash and cash equivalents at end of period $ 18,407 $ 26,517 ========== ===========
See accompanying notes. 5 SYLVAN LEARNING SYSTEMS, INC. AND SUBSIDIARIES Notes to Unaudited Supplemental Consolidated Financial Statements (Amounts in thousands, except per share amounts) March 31, 1998 Note A - Basis of Presentation --------------------- The accompanying unaudited supplemental consolidated financial statements have been prepared in accordance with generally accepted accounting principles for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. Operating results for the three months ended March 31, 1998 are not necessarily indicative of the results that may be expected for the year ended December 31, 1998. For further information, refer to the annual financial statements and footnotes thereto included in this report on Form 8-K. As discussed in Note E, on May 6, 1998, the Company consummated its acquisition of all of the outstanding stock of Aspect International Language Schools, B.V. and subsidiaries ("Aspect"). The acquisition has been accounted for as a pooling-of-interests and accordingly, the Company's financial statements have been restated to include the results of Aspect for all periods presented. As of the date of the issuance of these financial statements, the Company has not issued financial statements for a period including the merger date. Therefore, the accompanying unaudited consolidated financial statements are considered "supplemental". Upon the issuance of financial statements for a period that includes the date of the merger, the unaudited supplemental consolidated financial statements will become the historical unaudited consolidated financial statements of the Company. Note B - Income Taxes ------------ The tax provisions for the three month periods ended March 31, 1998 and 1997 are based on the estimated effective tax rates applicable for the full years. The Company's income tax provision of $2.3 million for the three month period ended March 31, 1998 consists of federal, state, and foreign income taxes. The Company's effective tax rate decreased from 42% during the first quarter of 1997 to 35% during the first quarter of 1998 mainly due to the effect of higher earning levels in certain lower tax jurisdictions. 6 Note C - Earnings Per Share ------------------ Aspect International Language Schools, B.V. and subsidiaries On May 6, 1998 the Company consummated its acquisition of all the outstanding stock of Aspect in exchange for 2,004,030 shares of common stock. The acquisition was accounted for as a pooling-of-interests and accordingly, the Company's consolidated financial statements for periods prior to the merger have been restated to include the combined results of operations, financial position and cash flows of Aspect (See Note A). In May 1998, the Company expensed approximately $5.0 million of direct costs incurred by the Company and the combining shareholders related to the merger. Aspect provides intensive English language instruction to students and professionals worldwide through its 19 language schools in five countries. Combined and separate results of operations of Sylvan and Aspect during the periods presented are as follows:
Previously Reported by the Company Aspect Combined -------------- --------- ------------ Three months ended March 31, 1998 Revenues $ 75,356 $ 10,967 $ 86,323 Net income (loss) $ 5,647 $ (1,380) $ 4,267 Earnings per common share - - diluted $ 0.12 - $ 0.09 Three months ended March 31, 1997 Revenues $ 51,944 $ 8,877 $ 60,821 Net income (loss) $ 3,447 $ (793) $ 2,654 Earnings per common share - diluted $ 0.08 - $ 0.06
7 Note C - Earnings Per Share ------------------ The following table summarizes the computations of basic and diluted earnings per share:
Three Months ended March 31, ---------------------------- 1997 1998 ------- ------- Numerator used in basic and diluted earnings per common share: Net income $ 2,654 $ 4,267 ======= ======= Denominator: Denominator for basic earnings per common share - weighted average shares 40,073 47,760 Effect of dilutive securities: Employee stock options 2,519 2,166 Common stock contingently issuable 290 - ------- ------- Total dilutive potential common shares 2,809 2,166 ------- ------- Denominator for diluted earnings per common share - weighted average shares and assumed conversions 42,882 49,926 ======= ======= Earnings per common share, basic $ 0.07 $ 0.09 Earnings per common share, diluted $ 0.06 $ 0.09
Note D - Reclassifications ----------------- Certain amounts in the 1997 financial statements have been reclassified to conform with the 1998 presentation. 8 Canter Effective January 1, 1998 the Company acquired all of the outstanding stock of Canter and Associates, Inc. and Canter Educational Productions, Inc. (collectively, "Canter"), commonly controlled companies, for an initial purchase price of $25 million in cash. Additional contingent consideration is payable over the next three years based upon Canter's meeting certain earnings thresholds. The acquisition was accounted for using the purchase method of accounting. During the first quarter of 1998, goodwill of approximately $23.6 million was recorded and is being amortized over a period of 25 years. Results of operations of Canter are included in the accompanying 1998 consolidated statement of income from January 1, 1998. Canter develops and markets staff development materials, including books and videotapes for teachers, as well as graduate level courses for educators that are delivered primarily through distance learning. The companies provide courseware for a complete distance learning Master's program offered by five independent colleges and universities. Additionally, Canter provides courseware for 11 other graduate level courses that are offered by 14 independent college and universities nationwide. Note F - Subsequent Events ----------------- In May 1998, the Company increased the number of authorized shares of common stock from 40,000,000 shares to 90,000,000 shares and declared a 3-for-2 stock split of its common stock for stockholders of record on April 8, 1998. Accordingly, all share and per share data including stock options, warrants and earnings per share information has been restated in the unaudited supplemental consolidated financial statements to retroactively reflect the stock split. 9 Note G - Stockholders' Equity -------------------- The components of stockholders' equity are as follows:
Foreign Additional Currency Total Common Paid-In Retained Translation Stockholders' Stock Capital Earnings Adjustments Equity ------ ---------- -------- ------------ ------------- Balance at January 1, 1998 $455 $301,897 $39,057 $(1,161) $340,248 Options exercised for purchase of 104 shares of common stock, including income tax benefit of $458 1 1,860 - - 1,861 Issuance of 965 shares of common stock in connection with the acquisition of NAI/Block 10 25,706 - - 25,716 Issuance of 80 shares of common stock in connection with other acquisitions - 119 41 - 160 Issuance of 23 shares of common stock in connection with the Employee Stock Purchase Plan - 438 - - 438 Foreign currency translation adjustment - - - 236 236 Net income for the three months ended March 31, 1998 - - 4,267 - 4,267 Repayment of distributions - - 238 - 238 --------- ------------ ------------- ------------ --------------------- Balance at March 31, 1998 $466 $330,020 $43,603 $ (925) $373,164 ========= ============ ============= ============ =====================
Note H - Contingencies ------------- From time to time, the Company may be a party to routine litigation incidental to its business. At this time, the Company is the defendant in a legal proceeding pending in the United States District Court for the Northern District of Iowa, Civil Action No. C96-334MJM, filed on November 18, 1996 by ACT, Inc., an Iowa nonprofit corporation formerly known as American College Testing Program, Inc. ("ACT"). ACT's claim arises out of the Company's purchase of contract rights to administer testing services for the National Association of Securities Dealers, Inc. ("NASD"). ACT has asserted that the Company tortuously interfered with ACT's relations, contractual and quasi-contractual, with the NASD, caused ACT to suffer the loss of its advantageous economic prospects with the NASD and other ACT clients and that the Company has monopolized and attempted to monopolize the computer-based testing services market. ACT has claimed unspecified amounts of compensatory, treble and punitive damages, as well as injunctive relief. The Company believes that all of ACT's claims are without merit. Note I - Business Segment Information ----------------------------
Three months ended March 31, ---------------------------- 1997 1998 ---- ---- Operating revenues: Learning Centers $ 9,231 $ 12,136 Contract Educational Services 17,574 26,620 Sylvan Prometric 34,016 47,567 -------- -------- $ 60,821 $ 86,323 ======== ======== Segment profit: Learning Centers $ 2,402 $ 2,707 Contract Educational Services 1,406 3,806 Sylvan Prometric 3,427 3,029 -------- -------- $ 7,235 $ 9,542 ======== ======== Segment assets: Learning Centers $ 21,694 $ 27,840 Contract Educational Services 28,820 82,382 Sylvan Prometric 167,376 273,758 -------- -------- $217,890 $383,980 ======== ========
There have been no changes since December 31, 1997 in the Company's method for identification of reportable segments or for determination of segment profit or loss. There are no significant intercompany sales or transfers. The following table reconciles the reported information on segment profit to income before income taxes reported in the consolidated statements of income for the three months ended March 31, 1997 and 1998, respectively:
Three months ended March 31, ---------------------------- 1997 1998 -------- --------- Total profit for reportable segments $ 7,235 $ 9,542 Corporate general and administrative expense (2,961) ( 3,327) Other income (expense) 335 367 ------- -------- Income before income taxes $ 4,609 $ 6,582 ======= ========
11 EX-99.4 14 EXHIBIT 99.4 EXHIBIT 99.4 ANGLO-WORLD EDUCATION (UK) LIMITED AUDITOR'S REPORT TO THE MEMBERS We have audited the financial statements of Anglo-World Education (UK) Limited on pages 5 to 18 which have been prepared under the accounting policies set out on page 9 and 10. RESPECTIVE RESPONSIBILITIES OF DIRECTORS AND AUDITORS As described on page 3 the company's directors are responsible for the preparation of financial statements. It is our responsibility to form an independent opinion, based on our audit, on those statements and to report our opinion to you. BASIS OF OPINION We conducted our audit in accordance with Auditing Standards issued by the Auditing Practices Board which are substantially the same as United States Generally Accepted Auditing Standards. An audit includes examination, on a test basis, of evidence relevant to the amounts and disclosures in the financial statements. It also includes an assessment of the significant estimates and judgements made by the directors in the preparation of the financial statements, and of whether the accounting policies are appropriate to the company's circumstances, consistently applied and adequately disclosed. We planned and performed our audit so as to obtain all the information and explanations which we considered necessary in order to provide us with sufficient evidence to give reasonable assurance that the financial statements are free from material misstatements, whether caused by fraud or other irregularity or error. In forming our opinion we also evaluated the overall adequacy of the presentation of information in the financial statements. OPINIONS In our opinion the financial statements give a true and fair view of the state of the company's affairs as at 31 December 1995, 1996 and 1997 and of its profit for each of the three years then ended. DELOITTE & TOUCHE Chartered Accountants Date: 27 July 1998 EX-99.5 15 EXHIBIT 99.5 EXHIBIT 99.5 SMITH, LANGE & PHILLIPS LLP CERTIFIED PUBLIC ACCOUNTANTS 33 NEW MONTGOMERY STREET, SUITE 1530 SAN FRANCISCO, CA 94105-4510 Tel. (415) 243-8833 Fax (415) 243-8840 June 11, 1998 INDEPENDENT AUDITOR'S REPORT ---------------------------- To the Board of Directors of American Study Program for Educational and Cultural Training, Inc. (ASPECT) We have audited the accompanying balance sheet of American Study Program for Educational and Cultural Training, Inc. (ASPECT) as of September 30, 1995 and the related statements of income and retained earnings, cash flows and supplementary schedules for the year then ended. The financial statements are the responsibility of ASPECT. Our responsibility is to express an opinion on the financial statements taken as a whole. We conducted our audit in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statements presentation. We believe that our audit provides a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of ASPECT as of September 30, 1995, and the results of its operations and its cash flows for the year then ended in conformity with generally accepted accounting principles. /s/ Smith, Lange & Phillips EX-99.6 16 EXHIBIT 99.6 EXHIBIT 99.6 SMITH, LANGE & PHILLIPS LLP CERTIFIED PUBLIC ACCOUNTANTS 33 NEW MONTGOMERY STREET, SUITE 1530 SAN FRANCISCO, CA 94105-4510 Tel. (415) 243-8833 Fax (415) 243-8840 December 10, 1996 INDEPENDENT AUDITOR'S REPORT ---------------------------- To the Board of Directors of American Study Program for Educational and Cultural Training, Inc. (ASPECT) We have audited the accompanying balance sheet of American Study Program for Educational and Cultural Training, Inc. (ASPECT) as of September 30, 1996, and the related statements of income and retained earnings, cash flows and supplementary schedules for the year then ended. The financial statements are the responsibility of ASPECT. Our responsibility is to express an opinion on the financial statements taken as a whole. We conducted our audit in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles use and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of ASPECT as of September 30, 1996, and the results of its operations and its cash flows for the year then ended in conformity with generally accepted accounting principles. /s/ Smith, Lange & Phillips EX-99.7 17 EXHIBIT 99.7 EXHIBIT 99.7 SMITH, LANGE & PHILLIPS LLP CERTIFIED PUBLIC ACCOUNTANTS 33 NEW MONTGOMERY STREET, SUITE 1530 SAN FRANCISCO, CA 94105-4510 Tel. (415) 243-8833 Fax (415) 243-8840 December 7, 1997 INDEPENDENT AUDITOR'S REPORT ---------------------------- To the Board of Directors of American Study Program for Educational and Cultural Training, Inc. (ASPECT) We have audited the accompanying consolidated balance sheet of American Study Program for Educational and Cultural Training, Inc. (ASPECT) and subsidiary as of September 30, 1997, and the related consolidated statements of income and retained deficit, cash flows and supplementary schedules for the year then ended. The financial statements are the responsibility of ASPECT. Our responsibility is to express an opinion on the financial statements taken as a whole. We conducted our audit in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of ASPECT as of September 30, 1997, and the results of its operations and its cash flows for the year then ended in conformity with generally accepted accounting principles. /s/ SMITH, LANGE & PHILLIPS -----END PRIVACY-ENHANCED MESSAGE-----